Is This Legal? Taxing Unrealized Interest.

Over6T | Nov 1, 2022 | 31 posts since 2012

I'm usually a "buy and hold" CD investor since I do not withdraw earning as they accrue and compound monthly. I've become aware that certain CU's will not allow you to withdraw the earned interest unless you break the CD. Thus, the accrued interest is an unrealized (unusable) gain so to speak. But, the CU in question (Mountain America, aka MACU) issues a 1099 for the interest earned during the year, yet the depositor has no access to it without breaking the CD.

It seems illegal, unethical or at least down right un-American to make me pay taxes on money that I can't spend!

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Answers

Choice | Nov 1, 2022 | 937 posts since 2020

First time experience in the CD world? If so, welcome to reality. It is realized AND recognized however, you may not have access to same!

GreenDream | Nov 1, 2022 | 358 posts since 2019

Words have meaning. In the financial world "unrealized gain" does not mean "unusable gain". An unrealized gain is:

" an increase in the value of the investment due to the increase in its market value and calculated as (Fair Value or market value – purchase cost). Such a gain is recorded in the balance sheet before the asset has been sold, and thus the gains are called Unrealized because no cash transaction happened."

In short it's unrealized because until you sell, the gain hasn't happened, it's not set in stone. The fair market value could drop tomorrow and your unrealized gain could become an unrealized loss.

With a CD, the gain is realized (whether or not it's unavailable for you to access) when the bank posts the interest to your CD (a cash transaction from the bank to your account has occurred when that happen). Regardless of what happens tomorrow, the gain will remain in your CD. It has been realized even if you don't currently have access to spend it. You may get hit with a penalty that wipes out some of that gain if you break the CD early, but the gain still happened, like it or not.

Ally6770 | Nov 5, 2022 | 4,294 posts since 2010

There was a time in the 70's or early 80's that you did not pay income tax on interest until the CD was cashed in or you received it. It has been too long ago to remember how it worked but I remember choosing our CD's by this scenario. Maybe Ken would have info on this.

midas89 | Nov 5, 2022 | 996 posts since 2017

In every other world besides the financial world, unrealized gain does mean unusable gain. One example: When every grocery store in my area was out of my favorite laundry detergent, I experienced unrealized Gain, which meant unusable Gain.

Seriously though, I think the rule should be that you are only issued the 1099 for the year you actually cash out the interest on the CD. I know it’s not the rule, so all we can do is add this unfairness to all the other unfairness we are subjected to.

w00d00w | Nov 5, 2022 | 360 posts since 2012

this original post raises for me a separate question about where a saver can go to get tax-deferred income, outside a tax-sheltered account. the ones that come immediately to mind are Savings Bonds and cash-value life insurance (universal or whole). i suspect Social Security benefits and certain types of annuities would also fit that profile. any others?

Over6T | Nov 5, 2022 | 31 posts since 2012

Partially answering your question: Treasury Bills and Bonds offer a state tax exemption. Adding this exemption makes treasuries much more attractive than CD. And I must say, in general, much less administrative hassle than dealing with Banks and CU's.

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