Interest on a certificate of deposit or other time deposit is taxed as ordinary income on your federal return in the year the bank credits it to your account, at the same rate as your wages. The principal you deposited is not taxed, but every dollar of interest gets stacked on top of your other income and taxed at your marginal rate. That’s the short answer to how CD interest is taxed. The longer answer covers when you owe tax on interest you can’t yet withdraw, how to report it, and how the picture changes inside a retirement account.1Internal Revenue Service. Topic No. 403, Interest Received
Ordinary Income, Not Capital Gains
The IRS treats interest from CDs, money market accounts, and similar time deposits as ordinary income.1Internal Revenue Service. Topic No. 403, Interest Received It doesn’t qualify for the lower long-term capital gains rates that apply to stocks. Whatever you earn in interest is added to the rest of your income, and the last dollar is taxed at your highest bracket.
Tax is due the moment the interest is credited to an account you can access, even if you leave it sitting there. This is the constructive receipt rule: interest that’s been made available to you counts as income for that year regardless of whether you actually withdraw it. There’s one narrow exception. If a portion of the interest genuinely cannot be withdrawn until the CD matures (as with some bonus or forfeiture arrangements), that portion isn’t taxable until the year you can first get at it.2eCFR. 26 CFR 1.451-2 – Constructive Receipt of Income
All of it counts. If you have CDs at three banks, the combined interest across all three is your taxable amount. And you owe tax on interest below the $10 reporting threshold too, even though the bank won’t send you a form for it.1Internal Revenue Service. Topic No. 403, Interest Received
Long-Term CDs and Original Issue Discount
If your CD has a term longer than one year, part of the interest may be treated as original issue discount (OID). OID is the gap between what the CD costs you and what it pays at maturity, and the IRS makes you include a slice of that gap in your income every year you hold the CD, not just at the end.3Internal Revenue Service. Publication 1212 Guide to Original Issue Discount (OID) Instruments
For CDs issued after 1984, the annual amount is figured using the constant-yield method, which pushes slightly more income into the earlier years. Your bank should send you Form 1099-OID if the annual amount is $10 or more. A de minimis rule allows OID to be treated as zero when the total is less than one-quarter of one percent of the maturity value multiplied by the number of full years to maturity.3Internal Revenue Service. Publication 1212 Guide to Original Issue Discount (OID) Instruments If no 1099-OID arrives and you think one should have, you’re responsible for computing the amount yourself.
How the Interest Gets Reported
Your bank issues Form 1099-INT if it paid you $10 or more in interest during the year, or Form 1099-OID for OID amounts of $10 or more.4Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Below those thresholds you still owe the tax; the bank just won’t paper it for you.1Internal Revenue Service. Topic No. 403, Interest Received
Where the numbers go depends on how much you earned:
- Under $1,500 in total interest for the year: report it directly on Form 1040.
- $1,500 or more: complete Schedule B, listing each payer and the amount received. Schedule B also asks about foreign accounts.
Withholding on CD Interest
Banks generally don’t withhold federal tax from CD interest the way an employer withholds from a paycheck. You pay when you file. The exception is backup withholding. If you don’t give the bank a correct taxpayer identification number, or the IRS has notified the bank that you’ve underreported interest or dividends in the past, the bank must withhold 24% of your interest and send it to the IRS.5Internal Revenue Service. Backup Withholding
You certify your TIN and withholding status on Form W-9 when you open the account. If you don’t return one, the 24% withholding kicks in automatically.6Internal Revenue Service. Request for Taxpayer Identification Number and Certification Backup withholding isn’t a separate tax. It’s a prepayment shown in Box 4 of your 1099-INT, and you claim credit for it on your return.
Early Withdrawal Penalties Are Deductible
Cashing out a CD before maturity usually costs you several months of interest as a bank penalty. That penalty is deductible on your federal return as an adjustment to income, so it reduces your adjusted gross income whether you itemize or take the standard deduction.
The amount shows up in Box 2 of Form 1099-INT, and you claim it on Schedule 1 of Form 1040. The deduction is allowed in full even if the penalty is larger than the interest the CD paid you during the year, which happens often when a multi-year CD is broken early in its term. Because it’s an above-the-line deduction, it also lowers your AGI for other tax benefits that phase out at higher income, such as the student loan interest deduction and some education credits.
State Taxes on CD Interest
Most states tax CD interest as ordinary income alongside the federal government. Eight states levy no individual income tax at all: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming. Washington taxes only capital gains, not interest. Everywhere else, your CD interest is added to your other income and taxed at your state’s rates, which run from below 3% to above 13% depending on the jurisdiction.
The 3.8% Surtax for Higher Earners
Interest counts as investment income, so higher earners may owe an additional 3.8% net investment income tax on top of the ordinary rate. The surtax kicks in when modified adjusted gross income exceeds:
- $250,000 for married couples filing jointly or qualifying surviving spouses
- $200,000 for single filers or heads of household
- $125,000 for married individuals filing separately
The 3.8% applies to the lesser of your net investment income or the amount by which your MAGI exceeds the threshold.7Internal Revenue Service. Topic No. 559, Net Investment Income Tax These thresholds are not indexed for inflation, so more taxpayers fall inside them each year.
CDs Held Inside an IRA
Putting a CD inside an Individual Retirement Account changes the answer completely. Interest earned on an IRA CD isn’t reported on a 1099-INT each year. The tax treatment depends on which type of IRA holds it.
Traditional IRA
Contributions may be deductible depending on your income and workplace plan coverage. Interest inside the account grows tax-deferred, and you owe nothing until you take distributions. When you do withdraw, the money is taxed as ordinary income. Distributions before age 59½ generally face an additional 10% tax on top of the regular income tax.8Internal Revenue Service. Retirement Plans FAQs Regarding IRAs Distributions
If a CD matures inside a traditional IRA, you can roll the proceeds into another CD or a different investment inside the IRA with no tax consequences, provided the money stays in the account.
Roth IRA
Contributions to a Roth IRA are made with after-tax dollars, so there’s no deduction upfront. Interest earned inside the account can come out completely tax-free as a qualified distribution once two conditions are met: you’re at least 59½, and at least five years have passed since your first Roth IRA contribution. Withdrawals of earnings that don’t meet both tests may be taxable and subject to the 10% early distribution penalty.8Internal Revenue Service. Retirement Plans FAQs Regarding IRAs Distributions
What Happens If You Leave Interest Off Your Return
Unreported CD interest is one of the easiest things for the IRS to catch, because the bank reports the same figures independently. When the numbers don’t line up, the IRS sends a notice, often a CP2000, proposing additional tax. Where the underreporting is attributed to negligence or disregard of the rules, the IRS can add a 20% accuracy-related penalty on top of the tax owed.9Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments Interest also accrues from the original due date.
The fix is straightforward. Check that the amounts on your 1099s match what you’re reporting. If you hold CDs at more than one bank, pull your IRS Wage and Income Transcript during filing season; it lists every 1099 the IRS has for you, and cross-checking against it catches missing accounts before the return goes in.