Do you pay taxes on CDs? Is CD interest taxable? And if so, how is interest paid on a CD?
A certificate of deposit, or CD, can be a good place to invest cash you won't need for a while, such as money for college or grad school. You'll tie up your funds for a determined period, usually between six months and five years, but you'll earn higher interest than you would on most savings accounts.
So, if you are considering investing in certificates of deposit, these are the right questions to ask. And remember, regardless of whether or not you make the decision to cash in your CD, you are required to report all interest which you have earned from it throughout the year.
Read More: Who Must File Income Taxes?
Report CD Interest Annually
If you buy a six-month CD in January and cash it during the same year, there's no surprise. You'll get your interest before the end of the year and claim it on your federal taxes for the year you receive it. However, if you have CD with a maturity greater than one year, you must report the interest earned every year, provided it is at least $10, according to the IRS. This rule applies to any type of savings certificate or time deposit at banks and other savings institutions.
You'll usually have to pay a penalty if you want to touch your original investment in a CD before the account matures. However, banks typically allow you to withdraw the interest from CDs as soon as it's credited without any penalty.
In general, the IRS considers that you've already received any interest that's been added to your account and that you can withdraw it without penalty. It doesn't make any difference whether or not you actually take it out.
The IRS requires savings institutions to report interest yearly on CDs that have terms of longer than a year. However, sometimes banks may report interest on a yearly basis for shorter CDs. If the bank allows you to withdraw interest without a penalty, it's normally taxable, even before maturity.
Otherwise, you'll have to claim the amount on your 1099-INT on your taxes. Prevent unpleasant surprises by finding out your bank's policy on reporting interest before you open a CD.
Tax on Interest Earned
You normally won't have trouble figuring out how much CD interest to claim on each year's income tax. The IRS requires every savings institution to send you a Form 1099-INT listing the taxable interest on your CDs and other accounts.
These forms normally arrive after the end of the tax year in January or early February. The IRS also receives a copy. Save your 1099-INT forms for tax filing time. However, you must claim any taxable interest even if a 1099 fails to arrive, so contact your bank to ask for a copy.
Interest income is taxed as ordinary income, which is one of the CD and savings account tax considerations you'll need to keep in mind when determining where to save your money. Your CD tax rate will depend upon your tax bracket.
Filing for the 2021 Tax Year
Read More: Form 1040: What You Need to Know
- Investor.Gov: Certificates of Deposit (CDs)
- IRS.Gov: Topic No. 403 Interest Received
- IRS.Gov: IRS provides tax inflation adjustments for tax year 2021
- IRS.Gov: 2022 tax filing season begins Jan. 24; IRS outlines refund timing and what to expect in advance of April 18 tax deadline
- IRS.Gov: Publication 550 Cat. No. 15093R Investment Income and Expenses (Including Capital Gains and Losses)