Interest income from a CD is taxed as ordinary income in the year you receive it

The interest you earn on a certificate of deposit is subject to federal income tax, and in most cases state and local income tax as well. The IRS treats CD interest the same way it treats interest from a savings account or money market account — as ordinary income, taxed at your regular income tax rate rather than at the lower capital gains rate.

How and when you pay tax on that interest depends on the CD's term and how the interest is paid out. A CD that matures in one year works differently from a five-year CD, and a CD that compounds interest monthly works differently from one that pays interest at maturity.

The financial institution holding your CD — your bank, credit union, or brokerage — will report the interest to you and to the IRS on a Form 1099-INT each January. You then report that amount on your tax return for the year in which you received the interest.

Key Takeaways

  • CD interest is taxed as ordinary income at your regular tax rate, not as capital gains, and you owe tax in the year the interest is paid or credited to your account.
  • Banks and credit unions report CD interest on Form 1099-INT, which you receive by January 31 and must report on your federal tax return.
  • If a CD matures in less than one year, you may owe tax on interest you have not yet received, depending on how the CD is structured and your tax accounting method.
  • Some CDs held in tax-advantaged accounts like traditional IRAs or Roth IRAs have different tax treatment, though the interest still accrues tax-deferred or tax-free depending on the account type.
  • State and local income taxes explore to CD interest in most states, though a few states do not tax interest income.

When you owe tax on CD interest depends on whether interest is paid before maturity

If your CD pays interest annually, semi-annually, quarterly, or monthly, you owe federal income tax on that interest in the year you receive it — even if you do not withdraw the money and let it stay in the account to compound. This is true whether the interest is deposited into the CD itself or paid into a separate account.

If your CD matures in one year or less and all interest is paid at maturity, you still owe tax on the interest in that same year. You report it on your tax return for the year the CD matures, not the year you opened it.

The exception is a CD held inside a traditional IRA or other tax-deferred retirement account. In that case, you do not owe tax on the CD interest when it accrues. Instead, you owe tax when you withdraw money from the IRA, and the withdrawal is taxed as ordinary income. If the CD is in a Roth IRA, the interest accrues tax-free and you owe no tax on withdrawals in retirement, provided you meet the account's withdrawal rules.

CDs longer than one year create a tax timing issue

A CD with a term longer than one year — say, three years or five years — creates a tax situation that catches some people off guard. If the CD compounds interest and does not pay it out until maturity, you still owe tax on the accrued interest each year, even though you have not received the money yet.

This is called phantom income or imputed interest. The IRS requires you to report the interest as taxable income in the year it accrues, not in the year you receive it. Your bank will report this on Form 1099-INT each January, showing the interest earned during that calendar year.

For example, a five-year CD paying 4.5% interest compounded annually will show interest on your 1099-INT in year one, year two, year three, year four, and year five — even though you do not touch the money until the CD matures. You owe tax on each year's interest as it accrues.

This is one reason some people prefer CDs that pay interest monthly or quarterly: the interest is paid out, so you receive actual cash to cover the tax bill rather than owing tax on money still locked in the CD.

State and local taxes explore to most CD interest

In addition to federal income tax, most states tax CD interest as ordinary income. The tax rate varies by state and by your income level. A few states — including Illinois, Mississippi, and Tennessee — do not tax interest income, so residents of those states owe federal tax on CD interest but not state tax.

Some states offer tax breaks for interest earned on CDs purchased from in-state banks or credit unions, though these breaks are uncommon and usually limited to small amounts. Check your state's tax authority website or speak with a tax professional if you live in a state with an unusual tax structure.

Local income taxes in cities and counties also explore to CD interest in some places. New York City, for instance, taxes interest income for residents. Again, the rate depends on where you live and your income level.

Early withdrawal penalties do not reduce your taxable interest

If you withdraw money from a CD before it matures, you typically owe an early withdrawal penalty — a fee charged by the bank. This penalty is a real cost to you, but it does not reduce the amount of interest you owe tax on.

You still report the full amount of interest earned on your tax return. The penalty is a separate loss that you may be able to deduct on your federal return, but only if you itemize deductions and only subject to certain limitations. Most people take the standard deduction, which means the penalty provides no tax benefit.

Your bank will report the gross interest on Form 1099-INT and may report the penalty separately on the same form. Read the form carefully to understand what each number represents.

CDs in taxable accounts versus tax-advantaged accounts

A CD held in a regular brokerage account or savings account at a bank is a taxable account. You owe tax on the interest each year as described above.

A CD held inside an IRA, 401(k), or other tax-advantaged retirement account follows different rules. In a traditional IRA or traditional 401(k), the interest accrues tax-deferred — you owe no tax until you withdraw money in retirement. In a Roth IRA or Roth 401(k), the interest accrues tax-free — you owe no tax on withdrawals in retirement if you meet the account rules.

This is one reason people use retirement accounts for CDs: the tax deferral or tax-free growth can add up over time. However, retirement accounts come with their own rules about when you can withdraw money and how much you must withdraw at certain ages. A CD in a taxable account offers more flexibility, even though you owe tax on the interest sooner.

How to report CD interest on your tax return

When you file your federal tax return, you report CD interest on Schedule B (Interest and Ordinary Dividends) if your total interest income is more than $1,500. If your total interest is $1,500 or less, you can report it directly on Form 1040 without filing Schedule B, though you still must report it.

Your bank will send you Form 1099-INT by January 31 showing the interest paid in the previous calendar year. The form lists the bank's name, your account number, and the amount of interest. Keep this form with your tax records.

If you receive a 1099-INT and the amount is wrong, contact your bank when ready. The bank will issue a corrected form if needed. Do not file your return with an incorrect amount; the IRS will match the 1099-INT to your return and flag any discrepancies.

State and local tax returns typically require you to report the same interest income, though some states have different thresholds or rules. Check your state's tax authority website for specific instructions.

Frequently Asked Questions

Do I owe tax on CD interest if I reinvest it into the same CD?

Yes. If the interest is credited to your account — whether it stays in the CD or is moved elsewhere — you owe tax on it in that year. The fact that you do not withdraw it does not change the tax obligation. Your bank reports the interest on Form 1099-INT regardless of what you do with the money.

What if my CD interest is less than $10?

You still owe tax on it. There is no minimum threshold for reporting interest income. Even small amounts must be reported on your tax return. However, your bank may not issue a Form 1099-INT if the interest is below a certain amount (usually $10), so keep your own records of all interest earned.

Can I deduct CD losses if I lose money?

CDs do not typically lose money in the traditional sense — you always get back at least your principal. However, if you withdraw early and pay a penalty that exceeds the interest earned, you have a net loss. This loss may be deductible, but only if you itemize deductions, and the rules are complex. Consult a tax professional about your specific situation.

Are CD interest rates different for tax purposes?

No. The interest rate you earn on a CD is the same regardless of tax treatment. The rate is set by the bank and does not change based on your tax bracket or filing status. However, the after-tax return — what you keep after paying taxes — will be lower for higher earners in higher tax brackets.

Do I report CD interest differently if the CD is in a joint account?

If the CD is in a joint account, the bank reports the full interest on Form 1099-INT to the Social Security number listed as the account owner or primary holder. You and the other account holder must decide how to split the interest for tax purposes and report it accordingly on your individual returns. Some banks allow you to specify how to allocate interest between joint owners.