Do I Have to Pay Taxes on CD Earnings?

Certificates of deposit (CDs) are a reliable way to grow your savings with a guaranteed interest rate over a fixed term. However, many savers don’t realize that they generally must pay taxes on CD earnings. Below, we’ll cover what to expect during tax time if you have a CD.

How are CDs taxed?

The interest you earn on a CD is considered income and is taxed according to your income tax bracket. For example, if you fall in the 24% tax bracket, your CD earnings will be taxed at a rate of 24%.

CD interest is taxable the year it’s earned, according to the IRS. This is true regardless of how the interest is paid out to you, including if it’s automatically reinvested in the CD.

Your bank or credit union keeps track of the amount of interest your CD earns in any given year. If your CD earned more than $10 during the year, your financial institution should send you Form 1099-INT.

When do you have to pay taxes on a CD?

When exactly you have to pay taxes on a CD you own will vary depending on the length of the CD's term:

• Short-term CD (one year or less): Interest earned on a short-term CD is taxable the year that the interest is paid. If you open a one-year CD and it matures the same year, you’ll owe taxes on it for that year.
• Long-term CD (more than one year): Long-term CD interest is taxed over the course of the CD's term. Let’s say you open a CD with a five-year term. In this case, you won’t owe taxes on three years’ worth of interest all at once. Instead, you’ll pay taxes on the interest earned as you go. In year one, year two, year three, year four and year five, you’ll pay separate chunks of taxes based on the interest from the CD you have earned in that particular year.

How to report CD earnings on your tax return

Once you receive Form 1099-INT from your bank or credit union, you’ll need to report the income on both your federal and state tax returns. Your taxable interest is listed in box 1 of Form 1099-INT.

You might receive Form 1099-INT via email, your online banking portal or in the mail. Banks are required to send Form 1099-INT by Jan. 31. If you don’t receive it by then, contact your bank.

Keep in mind that even if you don’t receive the form, you’re still required to report any interest you earn from a CD. You should be able to track down interest earnings on your CD account statements.

Do early withdrawal penalties affect taxes?

An early withdrawal penalty can apply if you remove money from a CD before the term ends. If this occurs, you can deduct the amount of the penalty, helping to offset some of your taxable income. For example, if you pay $50 in early withdrawal penalties, you can deduct $50 from your taxable income.

If you were charged an early withdrawal penalty, it will be listed in box 2 of Form 1099-INT.

How to avoid taxes on CD earnings

You can avoid paying taxes on your CD earnings by opening a CD within a tax-advantaged account, such as an individual retirement account (IRA) or 401(k). Here's how that can work:

• IRA CD: When you open a CD within an IRA, such as a traditional IRA, it’s called an IRA CD. IRA CDs combine the features of a CD with the tax benefits of an IRA. With a traditional IRA, taxes on the interest earned are deferred until you start taking withdrawals from the account. Additionally, contributions you make to a traditional IRA may be tax-deductible.
• 401(k) CD: You may also be able to open a CD within a 401(k) retirement plan. Like a traditional IRA, you typically won’t have to pay taxes until you withdraw money from the account, assuming it is a traditional 401(k) and not a Roth 401(k).

It’s important to speak to a financial planner to help you decide whether CDs are the right fit for your situation.

Do you have to pay taxes on other deposit accounts?

In addition to CDs, you generally must pay taxes on the interest you earn on the following types of accounts:

• Savings accounts
• Money market accounts
• Checking accounts

As with CDs, the tax on interest earned in savings accounts and other deposit accounts is based on your income and tax bracket. If you earn more than $10 on these accounts in any given year, banks are required to send you Form 1099-INT. And as with a CD, you must report the earnings when you file your tax return.