The IRS taxes CD interest as ordinary income in the year you earn it

Interest from a certificate of deposit is taxed as ordinary income at your federal tax rate, the same way the IRS taxes wages or salary. You owe tax on the interest even if the CD hasn't matured yet and you haven't touched the money. The bank will send you a Form 1099-INT each January showing how much interest you earned the previous year, and you report that amount on your tax return.

Most CDs are issued by banks and credit unions, and the interest is fully taxable. The only common exception is a CD held inside a tax-advantaged account like a traditional IRA or Roth IRA — those accounts shelter the interest from federal tax, though the rules for withdrawals differ between account types.

State and local taxes also apply to CD interest in most places. If you live in a state with income tax, you'll owe tax on the CD interest there as well. A few states exempt interest income entirely, but most do not.

Key Takeaways

  • CD interest is taxed as ordinary income at your federal tax rate in the year you earn it, even if the CD hasn't matured.
  • The bank sends you a Form 1099-INT by January 31 showing the interest earned, which you report on your federal tax return.
  • You also owe state and local income tax on CD interest unless you live in one of the few states that exempt interest income.
  • CDs held in IRAs or other tax-advantaged retirement accounts are not subject to federal tax on the interest, though withdrawal rules apply.
  • If you withdraw money early and pay a penalty, that penalty is not deductible from your taxable income.

When you owe tax on CD interest

You owe federal income tax on CD interest in the tax year when you earn it, regardless of whether you've withdrawn the money. If a CD matures on December 15 and credits interest to your account that day, you report that interest on your tax return for that year — even if you don't touch the money until the following January.

The exception is a CD in a traditional IRA or Roth IRA. In a traditional IRA, the interest grows tax-deferred, meaning you don't owe tax until you withdraw money in retirement. In a Roth IRA, the interest grows tax-free, and may have access to withdrawals are never taxed. Both types of IRAs have rules about when you can withdraw without penalty, so the tax deferral comes with restrictions.

If you own a CD in a regular taxable account and the interest is less than $10 in a year, the bank may not send you a Form 1099-INT. You still owe tax on that interest, though — you'll need to report it yourself on your return.

How to report CD interest on your tax return

The bank or credit union that issued your CD will mail you a Form 1099-INT by January 31 of the following year. This form shows the total interest you earned in the previous calendar year. If you have CDs at multiple institutions, you'll receive a separate 1099-INT from each one.

On your federal tax return, you report the total interest from all your 1099-INT forms on Schedule 1 (Form 1040), line 8, labeled "Interest." Add up all the interest from all sources — CDs, savings accounts, bonds, and any other interest-bearing accounts — and enter the total. The IRS matches this number against the 1099-INT forms they receive from the banks, so accuracy matters.

If you file state taxes, you'll also report the CD interest on your state return, usually on a line for interest income. The state form varies by location, but the concept is the same: you add up all interest earned and report it.

The tax impact of early withdrawal penalties

If you withdraw money from a CD before it matures, the bank charges an early withdrawal penalty. That penalty reduces the amount of money you receive, but it does not reduce your taxable interest income. You still owe tax on the full amount of interest the CD earned, even though the penalty reduced your net proceeds.

For example, if a CD earned $500 in interest but you withdrew early and paid a $75 penalty, you report $500 as taxable interest on your return. The $75 penalty is simply money you lost — it's not deductible. This is one reason early withdrawal can be costly: you pay tax on interest you didn't fully keep.

The one partial exception involves IRAs. If you withdraw from a traditional IRA before age 59½, you may owe a 10% early withdrawal penalty on top of income tax. However, certain exceptions exist — for a first home purchase, education expenses, or medical hardship, for instance. These exceptions are specific and narrow, so check IRS rules if you're considering an early IRA withdrawal.

Tax-advantaged alternatives to regular CDs

If you want to own a CD but reduce the tax burden, consider holding it inside a traditional IRA or Roth IRA. Both allow you to own CDs, and both defer or eliminate federal tax on the interest.

A traditional IRA CD lets the interest grow without annual tax. You pay income tax when you withdraw money in retirement, at which point you may be in a lower tax bracket. You can contribute up to $7,000 per year (or $8,000 if you're 50 or older), and you must begin withdrawals at age 73.

A Roth IRA CD grows tax-free, and withdrawals are never taxed if you follow the rules — you must be 59½ and have held the account for at least five years. Roth contributions are made with after-tax dollars, so you don't get an upfront deduction, but the tax-free growth can be valuable over time. Roth IRAs have no required withdrawal age, so the money can grow indefinitely.

Both IRA types have contribution limits and income limits for contributions, so check whether you're within the limits before opening one.

State and local taxes on CD interest

Most states tax CD interest as ordinary income at the state rate. A few states — including Pennsylvania, Illinois, and Mississippi — exempt interest and dividend income from state tax, which can save you money if you live there. Most other states tax it at the same rate as federal income.

Some cities and counties also impose local income tax on interest. New York City, for example, taxes CD interest at the local rate in addition to state and federal tax. If you live in a place with local income tax, check your local tax form to see where to report interest income.

If you live in a state that taxes CD interest and you own a CD in another state, you still owe tax to your home state on the interest. The location of the bank doesn't matter — your state of residence does.

Frequently Asked Questions

Do I owe tax on CD interest if I don't withdraw the money?

Yes. You owe federal and state income tax on CD interest in the year you earn it, even if the money stays in the CD and you never withdraw it. The IRS taxes the interest when it's credited to your account, not when you spend it.

What if I have multiple CDs at different banks?

Each bank sends you a separate Form 1099-INT. You add up all the interest from all the forms and report the total on your tax return. The IRS receives copies of all the 1099-INT forms, so make sure your total matches.

Can I deduct the early withdrawal penalty from my taxes?

No. The early withdrawal penalty is not deductible. You report the full interest earned as taxable income, and the penalty is simply a cost you bear. This is why early withdrawal can be expensive — you pay tax on interest you didn't fully receive.

Are CDs in a Roth IRA taxed?

No. Interest earned in a Roth IRA is never taxed federally, and may have access to withdrawals are tax-free. You must be 59½ and have held the account for at least five years to withdraw without tax. Contributions to a Roth are made with after-tax dollars, so you don't get an upfront deduction.

What if the CD interest is less than $10?

The bank may not send a Form 1099-INT if interest is under $10, but you still owe tax on it. Report the interest on your tax return even without the form. Keep your own records of all interest earned so you can report it accurately.