How Are CDs Taxed?

Taxation of Certificate of Deposit Income

The earnings you receive from a CD are treated as ordinary income — not as capital gains — and are taxed accordingly, meaning they are handled the same as any other simple or straightforward income that you receive.

It’s important to keep in mind that the amount you owe on your CD earnings will adhere to your tax bracket just like your other forms of ordinary income.

That puts higher earnings at a disadvantage, which Marc Guberti, CFPC, explains. “The real return an investor receives differs from what the bank promotes. If your bank’s 1-year CD offers 4.00% APY and your highest dollar is in the 22% tax bracket, you’re only making 3.12% APY on the CD after taxes. If inflation returns to the Fed’s preferred gauge of 2%, you’re real return is only 1.12% APY despite locking up your money for an entire year. Some stocks have dividend yields higher than 1.12%, and those distributions aren’t treated as ordinary income. Real returns are even less for people who are in higher tax brackets”

2024 Tax Brackets

Exceptions

Staying aware of a few different avenues could help lessen the immediate tax burden you face on the earnings you receive from a CD.

One strategy is to place your CD within a traditional IRA, 401(k) or other retirement account. By doing so, you can avoid paying taxes on the earned interest of the CD until you begin withdrawing money from the retirement account.

Another option to consider is opening a jointly held CD with your partner if they are in a lower tax bracket. This sets you up for a smaller tax bill on the income from the CD.

For both of these exceptions, it’s important to keep in mind that rules vary by state. While these strategies can help with federal taxes, your state may have its own qualifications.

Holding a CD in a long-term investment vehicle, such as a traditional IRA or 401(k), hasn’t typically been my recommendation due to the significant opportunity cost. However, with the top CDs in the market currently offering around 5.50%, this option has become highly attractive for investors seeking substantial yields without the associated risks.

Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting Professional

Thomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.

How To Report Your CD Income

You will receive information on your CD earnings through a 1099-INT form. Your financial institution will typically send this form to you at the beginning of the year.

When you file your tax return, you must report to the IRS any interest of $10 or more that you earn on your CD, even if you don’t receive a 1099-INT.

If your CD’s term is longer than one year, you should also be aware that you will have to report the interest earned by the CD each year, not all at once when the CD matures.

If you have a five-year CD that earned $50 in interest during the first year, you’ll receive a 1099-INT form and must report the $50 on your tax return.

Then, in the second year, you earn another $50 in interest income. You will also have to report this on your tax return and any other interest income earned in each of the remaining three years of the CD term.

The amount of interest income will be shown in box 1 of the 1099-INT form. You will need to report this amount on Schedule B and line 2b of your Form 1040 as taxable interest. Report tax-exempt interest on line 2a of the 1040.

Tax Implications of Inheriting a CD

There are tax implications of inheriting a CD. Factors like estate taxes, RMDs and whether the original holder had already paid income taxes can all affect the new owner.

Generally, when a beneficiary inherits a CD, the value of the CD is not taxable to the beneficiary for federal tax purposes. The IRS does not consider inheritances to be income. This includes the deposit amount and interest earned through the date of death. However, any interest earned on the CD after the date of death counts as income to the beneficiary and would be taxable.

Federal estate taxes may apply to assets of a deceased person worth more than $13.61 million as of 2024.

Whether the inherited CD is taxed at the state level depends on which state the beneficiary resides in. Twelve states and Washington, D.C., currently impose estate taxes, while six states impose an inheritance tax.

The tax implications of inheriting a CD can be complex and may vary depending on your specific situation. It can be helpful to consult with a tax professional to determine your specific tax obligations.