Discover the Tax Implications of CDs: What You Need to Know

When it comes to investing, Certificates of Deposit (CDs) are considered a safe and reliable option. However, like any investment, it’s essential to understand the tax implications associated with them. One common question that arises is, “are CD taxable?” The short answer is yes, but the specifics can be a bit more complex. This article will delve into the tax implications of CDs, providing you with the information you need to make informed financial decisions.

Are CD Taxable?

Yes, the interest earned on CDs is taxable. The Internal Revenue Service (IRS) considers the interest you earn from a CD as income, and it must be reported on your annual tax return. This applies whether you receive the interest payments or choose to reinvest them.

When Are Taxes Due on CD Interest?

Typically, taxes on CD interest are due in the year the interest is credited to your account. This is true even if you don’t receive the interest payments until the CD matures. For example, if you purchase a 5-year CD, you’ll need to report and pay taxes on the interest each year, not just at the end of the 5-year term.

How is CD Interest Taxed?

CD interest is taxed as ordinary income, not as capital gains. This means the tax rate could be anywhere from 10% to 37%, depending on your tax bracket. For example, if you’re in the 24% tax bracket and earn $500 in CD interest, you’d owe $120 in taxes on that interest.

What About Tax-Deferred or Tax-Free CDs?

There are some exceptions to the rule that CD interest is taxable. For instance, if you hold a CD in a tax-deferred account like an Individual Retirement Account (IRA), you won’t owe taxes on the interest until you start taking distributions. Additionally, some CDs, like those issued by state or local governments, may be exempt from federal taxes.

How to Report CD Interest on Your Taxes

Each year, your bank or credit union will send you a Form 1099-INT if you earned more than $10 in interest. This form will show the amount of interest you earned during the year. You’ll need to report this income on your tax return, typically on Schedule B of Form 1040.

What Happens If You Withdraw Early?

If you withdraw money from your CD before it matures, you may have to pay an early withdrawal penalty. This penalty is not deductible, and you’ll still owe taxes on any interest earned before the withdrawal.

Conclusion

While CDs can be a safe and reliable investment, it’s important to understand the tax implications before you invest. Remember, the interest earned on CDs is taxable and must be reported on your annual tax return. However, there are some exceptions for tax-deferred or tax-free CDs. Always consult with a tax professional if you have questions about your specific situation.

References

• Internal Revenue Service. (2020). Topic No. 403 Interest Received. Retrieved from https://www.irs.gov/taxtopics/tc403
• Investopedia. (2020). How Are Certificate of Deposit (CD) Taxes Calculated? Retrieved from https://www.investopedia.com/ask/answers/112515/how-are-certificate-deposit-cd-taxes-calculated.asp