Certificates of Deposit (CDs) are a popular savings option for individuals looking to earn interest on their deposits with minimal risk. However, understanding the tax implications associated with CD interest is crucial for ensuring compliance with tax regulations and optimizing your financial strategy.
Taxable Treatment of CD Interest
Interest earned from Certificates of Deposit (CDs) is considered ordinary income by the Internal Revenue Service (IRS) and is generally taxable in the year it is credited and available to you, whether withdrawn or left to compound. 1Internal Revenue Service. Topic No. 403 Interest Received
The tax rate applied to CD interest corresponds to your marginal tax rate, which ranges from 10% to 37% for the 2025 tax year, depending on total taxable income. 2Internal Revenue Service. Internal Revenue Bulletin 2024-45
Financial institutions report interest income of at least $10 on Form 1099-INT, which is provided to both you and the IRS. 3Internal Revenue Service. About Form 1099-INT, Interest Income
CDs held in tax-advantaged accounts like IRAs or 401(k)s have different tax rules. Interest earned in these accounts is tax-deferred and only taxed upon withdrawal, typically during retirement. This allows interest to compound tax-free. However, early withdrawals may result in penalties and taxes, so understanding the rules for your specific retirement account is important.
Forms and Reporting Requirements
Form 1099-INT is the primary document for reporting CD interest, issued by financial institutions when interest income exceeds $10. This form provides details on interest earned and is necessary for preparing an accurate tax return. Taxpayers should always verify the information on the form against their own records.
Interest income must be reported on individual tax returns. If total interest exceeds $1,500, it must be itemized on Schedule B of Form 1040. 4Internal Revenue Service. About Schedule B (Form 1040), Interest and Ordinary Dividends Taxpayers with foreign accounts or other complex arrangements may also need to file additional forms, such as the FBAR (FinCEN Form 114) or Form 8938.
State and Federal Filing Differences
State and federal tax requirements for CD interest can vary. Federally, all interest income must be reported as taxable income, using forms like the 1099-INT and Schedule B. State tax rules, however, differ based on the state’s tax code.
States like Florida and Texas, which do not impose state income taxes, exempt residents from additional taxation on CD interest. In contrast, states like California and New York require residents to include CD interest on their state tax returns, potentially increasing the effective tax rate. Some states offer deductions or credits to offset the tax burden, so it’s important to review your specific state’s tax rules.
Consequences for Non-Reporting
Failing to report CD interest can lead to significant penalties and complications. The IRS uses forms such as the 1099-INT to verify the accuracy of tax returns. Discrepancies between reported income and IRS records may trigger an audit. If underreported income is identified, penalties, interest on unpaid taxes, or even legal action may follow.
If you underreport income, the accuracy-related penalty is generally 20% of the underpayment attributable to negligence or substantial understatement. 5Internal Revenue Service. Accuracy-Related Penalty Separately, failure-to-file and failure-to-pay penalties can apply: the failure-to-file penalty is typically 5% of the unpaid tax per month (up to 25%), and the failure-to-pay penalty is typically 0.5% per month (up to 25%); interest on any unpaid tax accrues from the return’s due date and compounds daily. 6Internal Revenue Service. Topic No. 653 IRS Notices and Bills, Penalties and Interest Charges