How CDs Are Taxed: Tax Planning Guide

Certificates of deposit (CDs) offer a predictable way to earn interest, but can surprise you at tax time. The IRS treats interest earned on CDs as taxable income, even if it remains in the account. Most banks report this interest annually, and the IRS typically taxes it as ordinary income. However, tax-advantaged accounts like IRAs may allow deferral of taxes on CD earnings. These depend on the type of account and contributions made. Understanding how your CDs are taxed can help you avoid mistakes that offset your gains.

A financial advisor can explain how CDs impact your long-term goals and overall tax strategy.

What Are CDs and How Do They Work?

A certificate of deposit (CD) is a fixed-term savings account offered by banks and credit unions. CDs pay interest in exchange for leaving the funds untouched for a set period of time. Unlike regular savings accounts, CDs typically offer higher interest rates but impose penalties for early withdrawals. The term length can range from a few months to several years, with longer terms often yielding higher rates.

When opening a CD, the account holder agrees to a fixed interest rate and maturity date. The interest accrues over time according to the rate. At maturity, the depositor can either withdraw the funds or roll them into a new CD. Banks may offer different types of CDs, including traditional and high-yield accounts, each catering to different financial goals.

While you can take money out early before the end of your CD’s term, you’ll have to pay a penalty. It varies depending on the financial institution and the terms of your agreement. The length of time you left the money in the CD also affects early withdrawal penalties. The exception to this rule is the no-penalty CD.

Do You Pay Taxes on CD Interest?

The timing of the tax can depend on the CD’s terms. The IRS considers CD interest taxable income in most cases, even if you don’t withdraw the funds. Interest generally becomes taxable income when you receive it or can withdraw it without paying a substantial penalty. Different rules, including original issue discount rules, can apply when interest is deferred for more than one year. Banks generally issue Form 1099-INT when they pay at least $10 of reportable interest during the year.¹

Tax treatment can vary for CDs held in tax-advantaged accounts, such as IRAs. The IRS may exempt, or defer, the taxes on the earnings in these accounts. However, for CDs in standard taxable accounts, the IRS typically taxes interest as ordinary income. The rate depends on the account holder’s marginal tax rate.

How to Report CD Income on Your Tax Return

The tax you owe on CD interest depends on your overall income and tax bracket, not just the rate the CD pays.

The institution that holds your CD will provide you with a 1099-INT statement at the beginning of the year that will detail your CD yield for the previous year. You’ll get this even if you didn’t cash out the money on your CD and instead invested it into a new CD. If your CD generates at least $10 of reportable interest, the financial institution generally must issue a Form 1099-INT. You generally report taxable interest on Line 2b of Form 1040, not Line 3, even if you do not receive a Form 1099-INT.

You may need to include a Schedule B for “Interest and Ordinary Dividends” if you meet any of the IRS requirements, including having more than $1,500 of taxable interest or ordinary dividends for the tax year.

How to Avoid Tax on CD Interest

While CD interest is generally taxable, certain strategies can help defer or reduce tax liability. Here are some options to consider:

Time CD maturity with tax consequences in mind: The timing of taxable interest depends on the CD’s terms and federal tax rules, so choosing a maturity date in a lower-income year does not necessarily defer all of the interest until that year.
Use tax-advantaged accounts: Holding CDs in a Traditional IRA allows interest to grow tax-deferred until withdrawals begin. Roth IRA CDs offer tax-free growth if withdrawals meet IRS requirements.
Invest in municipal bonds: Unlike CDs, municipal bond interest is often exempt from federal income taxes and may also be state tax-exempt if issued by your home state. However, these bonds carry different risks than CDs.
Consider U.S. Treasury securities: Treasury bonds and I bonds offer tax advantages. Treasury bond interest is exempt from state and local taxes, while I bond interest can be deferred until redemption.

Is Putting Money in a CD a Good Idea?

Experts sometimes jokingly refer to CDs as “certificates of depreciation.” Whether a CD keeps pace with inflation depends on the rate you lock in and inflation during the CD’s term. Locking money into a CD guarantees a rate of return. However, you may get a better rate with a high-yield savings account or Series I savings bonds. The difference here comes down to liquidity. Series I bonds lock up your money for at least a year to get a return on your investment. However, a high-yield savings account keeps your money available in case of emergency while it goes to work for you.

Strategically moving around large sums of money to different accounts for new-customer signup bonuses can also net you a higher yield than a CD while keeping your money more accessible.

If you’re considering putting your money in a CD to protect it from market volatility and recession fears keep in mind that you may not want to pull out of investing entirely. Past performance can’t guarantee future results, but historically market downturns have been the best times for people to invest their money for long-term growth. A diversified investment portfolio has a greater growth potential than CDs but also exposes investors to market risk and possible losses.

Common Tax Mistakes CD Holders Make

Don’t assume that the IRS postpones taxes on CD interest until you withdraw the money or the CD matures. Depending on the CD’s terms, interest may be taxable before maturity. A holder of a multi-year CD may therefore have taxable interest during the term even if the principal remains untouched.

Multi-year CDs can create additional questions about when interest becomes taxable. CDs that defer interest for more than one year may face original issue discount rules, which can require recognizing income as it accrues. Reviewing the tax forms provided by the financial institution can help account holders determine the amount reported for a particular year.

Many holders of taxable CDs overlook the fact that early withdrawal penalties are tax deductible, which can offset some of the cost of cashing out a CD before it matures. If you cash out a CD before it matures and the bank charges a penalty, you can deduct that amount on your federal return as an adjustment to income. It appears on Schedule 1 of Form 1040 and reduces adjusted gross income regardless of whether you itemize.

CD interest can also affect income-based thresholds that many people do not think about. For retirees, additional interest income can increase provisional income and cause a larger portion of Social Security benefits to become taxable. It can also push modified adjusted gross income above the levels that trigger IRMAA surcharges on Medicare Part B and Part D premiums.

For taxpayers who earn significant CD interest alongside other income, failing to adjust estimated quarterly payments is another common error. If you are self-employed or have other income not subject to withholding, a large CD portfolio generating thousands of dollars in annual interest can create an underpayment penalty at filing time. Updating estimated payments to account for expected CD interest can help avoid this.

State tax treatment may also differ from federal. While CD interest is taxable at the federal level in nearly all cases, state rules vary. A few states do not tax interest income at all, while others tax it at their full ordinary income rate.

How Much Tax Will You Pay on CD Interest?

The federal tax generated by CD interest is based on your taxable income. There is no special federal rate specifically for CDs. Instead, the interest becomes part of your taxable income and is subject to the same ordinary income tax brackets that apply to other income. In 2026, those marginal rates run from 10% to 37%.²

For example, consider a single filer with $60,000 in taxable income who earns another $2,000 from a CD in 2026. The 22% bracket applies to taxable income above $50,400 and up to $105,700. Since the additional interest keeps this taxpayer within that range, the extra federal tax would be $440:

$2,000 × 22% = $440

This example covers federal income tax only. Depending on the taxpayer’s state of residence, state taxes could apply as well. If CD earnings push taxable income into the next federal tax bracket, only the portion that crosses the threshold is subject to the higher marginal rate.

Bottom Line

Interest earned on a CD is taxed as ordinary income, regardless of whether you withdraw it or leave it in the account.

The IRs taxes the interest you earn on a CD as ordinary income at your marginal tax rate. While the yield represents the rate of return on the CD, the amount you actually owe in taxes depends on your income and tax bracket. When comparing a CD with other savings or investment options, consider the CD’s current rate, liquidity restrictions, potential early withdrawal penalty and after-tax return rather than assuming one type of account will always offer a higher yield.

Tips on Taxes

A financial advisor can offer insight and guidance as you work to handle your securities in a tax efficient way. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use our no-cost income-tax calculator to get a quick estimate of what you will owe the federal government.

Article Sources

All articles are reviewed and updated by SmartAsset’s fact-checkers for accuracy. Visit our Editorial Policy for more details on our overall journalistic standards.

“Publication 550 (2025), Investment Income and Expenses | Internal Revenue Service.” Home, https://www.irs.gov/publications/p550. Accessed Oct. 3, 2026.
“Federal Income Tax Rates and Brackets | Internal Revenue Service.” Home, https://www.irs.gov/filing/federal-income-tax-rates-and-brackets. Accessed Oct. 3, 2026.