Are CDs Taxable? 20 Things To Know Before You Invest

When considering investment options, you should understand any tax obligations associated with each choice. Certificates of deposit are no exception. While CDs offer stability and guaranteed returns, it’s important to be aware of how taxes can impact your earnings.

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In this article, GOBankingRates will explore whether or not investing in CDs are taxable, and offer additional insights to help you this tax season.

1. Are CDs Taxable?

Yes, the interest gained from CDs is considered taxable income, just like interest from any other account or investment product. The interest counts as regular income and is treated like any other standard income with regard to both federal and state income taxes. However, there are many finer details that investors should know before they let taxes affect their decisions.

2. Interest Income Taxation

The interest earned on CDs is subject to federal and, in some cases, state income taxes. The interest income generated from CDs is typically considered taxable income in the year it is earned.

It is important to report this income accurately on your tax return and pay any applicable taxes. For short-term CDs, meaning those with terms 12 months or shorter, interest is only taxable at maturity. However, this isn’t the case for terms over 12 months. The interest from these CDs is taxable during the tax year when it accrues.

3. Do CDs Pay Interest Monthly or Yearly?

CDs rely on compound interest, so they don’t pay out regular disbursements of interest like a savings account might. This means that while investors still have to pay tax on accrued interest for long-term CDs each year, they can’t actually claim that interest yet.

When is the compounding schedule on CDs? This can vary but it’s typically monthly or quarterly, so the appropriate fraction of the percentage is applied at the end of each month or quarter. The end result is that higher frequency compounding means more overall interest once the CD reaches maturity.

4. 1099-INT Form

The 1099-INT form outlines the amount of interest earned from the CD. Banks and financial institutions are required to provide a 1099-INT form to account holders who earn more than $10 in interest income during the year. However, keep in mind that the IRS guidelines require the filing of any interest income, even when below $10. Tax filers may have to manually review their statements to find this value.

5. Reporting Interest Income on Form 1040

Once the investor has received their 1099-INT form from the bank, they can use it to report interest income on Form 1040 for their tax filing. Their Form 1099-INT will show the total taxable interest income for that year in Box 1.

The tax filer must enter total taxable interest income on line 2b of their Form 1040. If they have taxable interest income outside of the income in Box 1 of Form 1099-INT, such as any accounts or holdings at different banks, they must add the sum total to Form 1040.

6. Do You Need to Complete Schedule B?

When filing taxes, some CD holders may be required to fill out a Schedule B form in addition to Form 1040. This form reports both interest and dividend income and is required whenever the taxpayer receives more than $1,500 in taxable interest or dividends that tax year from all sources.

The Schedule B form requires the name of the payer and the total amount from each individual Form 1099-INT and Form 1099-DIV that the taxpayer receives.

7. What Does Form 1099-OID Mean?

In some cases, CD holders may receive a Form 1099-OID in place of Form 1099-INT. OID stands for Original Issue Discount, and it typically refers to CDs and other bonds that were issued at a price lower than their redeemable value. This is usually only the case when purchasing CDs through brokerages rather than banks.

Form 1099-OID contains total taxable interest in Box 1. This value is reported on Form 1040. There’s no need to submit Form 1099-OID with the tax return, but it should be retained for future reference.

8. Do You Pay Taxes on CD Interest?

The interest from CDs is taxable income, but a person’s individual tax situation also plays an important role in whether they must pay taxes and how much. CD interest is taxed as regular income, so if a person’s income is low enough or deductions high enough, then they may not owe taxes.

There are also ways to reduce or defer taxes on CD interest. Various retirement accounts can either defer CD interest taxes to the year of withdrawal or even make the interest non-taxable income when certain conditions are met.

9. What Happens to a CD When It Reaches Maturity?

When the CD matures, the holder can withdraw the principal and interest or leave it as cash in the account where it was held. Most banks and institutions also provide the option to renew the CD, reinvesting the principal and earnings for a new term, likely with a new interest rate. However, the interest earned is still taxable even if it is reinvested in a renewed CD upon maturity.

10. Taxes on Brokered CDs

Standard CDs can be purchased directly from banks and other financial institutions. However, brokered CDs are purchased from brokers on a secondary market rather than directly from banks.

One critical difference between the two is that brokered CDs pay out interest out at regular intervals. While this means that holders don’t enjoy the automatic compounding provided by regular CDs, it can offer greater flexibility. These interest payouts are taxable for the tax year in which the individual payout takes place.

11. Tax Rates and Bracket Considerations

The tax rate applied to your CD interest income depends on your overall taxable income and your tax bracket. The income from CDs is typically taxed at your marginal tax rate, which means it is taxed at the same rate as your other sources of income.

It is important to consider how your CD interest income impacts your overall tax liability and to plan accordingly. Here are the federal income tax brackets for tax year 2024 [9]:

This table alone isn’t enough to determine federal income tax. There are also deductions to be claimed that can greatly reduce the amount owed. Anyone filing their own taxes should consider reaching out to a tax professional to ensure that they’re claiming all possible deductions to lower their payable taxes.

12. Early Withdrawal Penalties

CDs are a secure and low-risk investment option that locks in an investment over the course of the term. While there is typically a way to withdraw money early by breaking the CD term, this will incur penalties against the interest and even the principal in some cases. This must be reported properly at tax filing time.

Account holders who withdraw CDs early will still receive a Form 1099-INT. Along with the interest earned, this form also provides information about any early withdrawal penalties. When filling out interest income details on their Form 1040, taxpayers can report early withdrawal penalties as a deduction, potentially offsetting payable taxes on CD interest.

13. What Is the Biggest Downside To Putting Your Money in a CD?

CDs provide a variety of benefits, and finding the best CD rates can be an effective strategy for investors with certain risk thresholds and timelines. However, there are some downsides that potential investors should consider. Taxes may be one of them, as other similar assets, such as Treasury bonds, may be more tax advantageous.

Treasury bond interest still incurs federal income tax but not state income tax, while CDs incur both. Liquidity is another major concern for CD investors. Investments are locked in for the length of the term, leaving investors unable to take advantage of changes in interest rates without incurring heavy penalties.

14. State-Specific Tax Considerations

In addition to federal taxes, CDs may also be subject to state income taxes. It’s important to understand the tax laws in your specific state and how they apply to CD investments.

Some states may have different tax rates or exemptions, which can impact your overall tax liability.

15. States That Don’t Tax CD Interest

CDs are subject to state income tax, but there are some states that don’t have income tax or don’t include interest as taxable income. The seven states that don’t levy any individual income tax include:

• Alaska

• Florida

• Nevada

• South Dakota

• Tennessee

• Texas

• Wyoming

Washington has an individual income tax, but only on capital gains.

16. States That Do Tax CD Interest

The remaining 42 states, along with the District of Columbia, do have a state income tax that applies to CD interest. These range widely from as high as 13.3% for California to as low as 2.5% for Arizona and North Dakota in 2024. New Hampshire is notable as it doesn’t levy individual income tax on salary but instead exclusively taxes income from dividends and interest. This means that CD holders can see their payable taxes on accrued interest vary significantly depending on their state of residence.

17. Taxes on Jointly Held CDs

CDs are also assets that can be held jointly in some cases. This will affect how interest must be reported for tax purposes. The total interest must be divided among the holders per their proportionate share of the CD. They must then report that income when filing their taxes.

Of course, one of the scenarios where CDs are held jointly is when a married couple owns them in a shared account. If they are filing a joint return as a married couple, they can treat the CD interest the same way they would any other income.

18. Holding CDs in Tax-Advantaged Accounts

Tax-advantaged accounts can help CD holders improve their tax situation and potentially avoid paying taxes on interest, at least for the current tax year. CDs can be held in IRAs, allowing the holders to contribute on a pre-tax basis. Taxes on interest aren’t payable as they accrue, but instead, income taxes are deferred until withdrawals are made from the IRA.

Another potential option is purchasing CDs in a health savings account. This reduces taxable income and allows those investments and accrued interest to be put toward qualified medical expenses tax-free.

19. CDs and Roth IRAs

A Roth IRA is another potential option for avoiding taxes on CD interest. While there is no reduction in taxable income when investments are made into a Roth IRA, those investments grow tax-free, meaning that accrued CD interest doesn’t incur taxes.

Of course, there are certain guidelines that restrict Roth IRA withdrawals. For account holders aged 59 1/2 and under, the principal can be withdrawn at any time without additional taxes or penalties. However, withdrawing earnings, including interest, can incur both taxes and penalties. For those over 59 1/2, withdrawals are completely tax-free as long as they’ve had their Roth IRA for at least five years.

20. Are CDs Subject to Estate Tax?

CDs, like other assets, are included in an individual’s estate after their passing and may be subject to estate tax. This is only the case when the value of the estate exceeds the estate tax exemption, which is $13.61 million for individuals and $27.22 million for married couples for tax year 2024.

Any interest earned on a CD after the death of the account holder will be considered interest for the eventual beneficiary, even if it takes some time for the estate to be settled.

Consult a Tax Professional

Given how complex tax laws are, it’s always advisable to consult a qualified tax professional when assessing any tax advantages and disadvantages of investing in CDs.

A tax professional can provide personalized guidance based on your specific situation and help you make the right decision on your CD investment.

This article originally appeared on GOBankingRates.com: Are CDs Taxable? 20 Things To Know Before You Invest