Are CDs Tax Exempt?

Certificates of deposit (CDs) provide a way to save money and earn interest on that money while doing so. According to the IRS, if the interest earned during the tax year exceeds $10, you must report it on your tax return and pay taxes on it. This could negatively impact your return on this investment tool, so it’s important to consider how the CD interest is taxed in order to determine if placing your money in a CD is worth the effort. 

Key Takeaways

  • The IRS will tax all CD interest earned during a tax year that exceeds $10.
  • For CD terms longer than one year, you will have to pay taxes on interest earned each tax year during the CD term. 
  • Early withdrawal penalties may offset taxes owed on CD interest. 

How Does the IRS Tax Interest Earned on a CD?

If it exceeds $10, any interest earned on a CD during the tax year is considered income, and the IRS will tax it as such on your tax return. The banking institution holding your CD is required to send you a 1099-INT stating the amount of interest earned on the CD during the tax year. You will receive this document and pay taxes accordingly, even if you roll the principal of the CD into a new CD. 

In the event you don’t receive a 1099-INT from your banking institution but have records of earning more than $10 in interest on your CD, you still have to report it to the IRS on your tax return. 

CDs With Terms of More Than One Year

If your CD has a term of more than one year, you will pay taxes on any interest earned for each year of the CD term. For example, if you have a three-year CD and you earn $50 in interest during the first year of the term, you will report $50 on your tax return as income. During the second year, if you earn another $50 in interest, you again will report $50 on your tax return as income, and the same for the remaining year of the CD term. 

Exceptions to Paying Taxes on CD Interest

If the CD is placed in a tax-deferred 401(k) or individual retirement account (IRA), any interest earned on the CD may be exempt from paying taxes in the year it was earned. Instead, you will pay taxes on those monies when they are withdrawn from the 401(k) or IRA during retirement. Of course, this is provided your annual contribution to the retirement account remains below the contribution limits set by the IRS. For 2022, that limit is $6,000; if you’re age 50 or older, that limit is $7,000.

How Much Will I Pay in Taxes on CD Interest?

The amount of taxes you pay on earned CD interest varies based on your specific tax bracket as well as the dollar amount of your gain. To get an idea of how much you could pay in taxes, talk with a tax professional to evaluate your individual financial situation and provide a tax estimate.

When I Cash a CD, Is It Considered Income?

If your CD has a principal amount of $10,000 and earns $200 in interest at the time you cash it in, only the $200 in earned interest is considered income. You should receive a 1099-INT in the amount of $200 (box 1) from your banking institution.

Do Early Withdrawal Penalties Affect How Much I Pay in Taxes for CD Interest?

If you withdraw the money from your CD before the maturity date, your banking institution likely will charge an early withdrawal penalty. If it does, you can deduct the amount of the early withdrawal from your penalty, which could offset how much you pay in taxes on any earned interest.

For instance, if you earned $25 in interest (box 1 on your 1099-INT), you will pay taxes on that $25. However, if you pay an early withdrawal penalty (box 2 of your 1099-INT), you can deduct that $50 on your tax return, which could offset the taxes paid on the earned interest. 

The Bottom Line 

Simply put, yes, the IRS will tax all interest earned on your CD that exceeds $10. However, it will only do so for each tax year the interest is earned. So if you have a three-year CD, you will pay taxes only on interest earned during the current tax year. If the CD is placed in a 401(k) or IRA account, taxes will be deferred until distributions are taken from those accounts. 

Article Sources

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  1. Internal Revenue Service. "Topic No. 403 Interest Received."

  2. Internal Revenue Service. "Traditional and Roth IRAs."

  3. Internal Revenue Service. "Form 1099-INT, Interest Income."

  4. Internal Revenue Service. "Instructions for Forms 1099-INT and 1099-OID: Box 2. Early Withdrawal Penalty."