Certificates of deposit provide a secure investment because of the guaranteed interest rate and Federal Deposit Insurance Corporation coverage that protects up to $250,000 per depositor per bank in the event the bank goes under. Interest income, including the interest paid on your CD, counts as taxable income. How much you pay in taxes depends on your tax bracket -- the higher your bracket, the higher your tax bill.
The interest you earn on your certificate of deposit counts as taxable income when you file your tax return, but any principal you receive back when you cash out your CD won't count as taxable income. For example, if you cash out a CD and receive $1,000 -- $950 that you contributed and $50 of interest -- you only have $50 of interest income to declare. Even if you don't make the minimum amount to be sent a Form 1099-INT, you're still responsible for reporting the interest you earned on your taxes.
Early Withdrawal Penalties
If you have to cash out your CD early, you'll be stuck paying a hefty penalty to your bank. When you file your tax return, you'll get to offset your interest with the penalty, but you have to report each item separately. For example, if you have $500 in interest and a $300 penalty, you have to report the full $500 as interest, then claim the $300 as a deduction. But at the end of the day, you only add $200 to your taxable income.
Net Investment Income Tax
Though it's not likely to affect you, your CD interest is also subject to the net investment income tax. This is an extra 3.8 percent federal tax on investment income, including interest earned on CDs, that applies when your income is over the annual limit for your filing status. As of 2013, the thresholds are $250,000 if you're married filing jointly, $200,000 if you're single and $125,000 if you're married filing separately.
Extra Tax Paperwork
Depending on how much interest income you have, including your income from a certificate of deposit, you might have a little extra paperwork to fill out at tax time. If you have more than $1,500 in interest income during the year, you're required to complete Schedule B and attach it to your tax return. Schedule B lists each source of interest income during the year, but it won't increase your tax bill.
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