You pay tax on interest from both checking accounts and CDs, but not on the money itself

The IRS taxes interest income — the money the bank pays you for letting them hold your funds. Whether that interest comes from a checking account, a savings account, or a CD, it counts as taxable income in the year you earn it. The principal amount you deposit is never taxed; only the interest is.

For CDs specifically, you report the interest even if you don't withdraw it yet. If you have a one-year CD that matures in December and you don't touch the money until January, you still owe tax on that year's interest in the tax year it was earned, not when you withdraw it.

Checking accounts typically earn little or no interest, so most people don't owe tax on them. But if your checking account does pay interest — some high-yield checking accounts do — that interest is taxable the same way.

Key Takeaways

  • Interest from CDs and checking accounts is taxable income; you report it on your federal tax return in the year you earn it.
  • The bank will send you a Form 1099-INT if your interest exceeds $10 in a calendar year, and you must report that amount to the IRS.
  • You owe tax on CD interest even if you don't withdraw the money or if the CD hasn't matured yet.
  • State and local taxes may also apply to interest income, depending on where you live.

How the IRS finds out about your interest income

Banks report interest to the IRS using a Form 1099-INT. If you earned $10 or more in interest during the calendar year, the bank must send you a copy and file one with the IRS. You receive it by January 31 of the following year.

The IRS cross-checks the 1099-INT against your tax return. If you don't report the interest that appears on the form, the IRS will notice the discrepancy. This is one of the easiest income sources for the IRS to verify because banks report it automatically.

If your interest is under $10, the bank may not send a 1099-INT, but you still owe tax on it. You are responsible for reporting all interest income, whether or not you receive a form.

When you owe tax on CD interest before the CD matures

Most CDs work on a calendar-year accrual basis. This means you owe tax on the interest in the year it accrues (builds up), not in the year you withdraw the money or the CD matures.

Example: You buy a two-year CD on November 1 that pays 4.5% annually. By December 31 of that year, you have earned two months of interest. You owe tax on those two months in that tax year, even though the CD won't mature for another 22 months and you can't touch the money.

The exception is a CD with a penalty for early withdrawal. If you withdraw money before maturity and pay an early withdrawal penalty, you can deduct that penalty from your interest income on your tax return. You don't get to avoid the tax, but the penalty reduces the taxable amount.

Federal tax rates on interest income

Interest income is taxed as ordinary income, not at capital gains rates. This means it is taxed at your regular income tax bracket — the same rate as wages or salary.

If you are in the 22% federal tax bracket and earn $500 in CD interest, you owe roughly $110 in federal tax on that interest (before any deductions or credits). If you are in the 12% bracket, you owe roughly $60. The exact amount depends on your total income and filing status.

Interest income does not may have access to for the lower long-term capital gains rates, even if you hold the CD for years. It is treated the same as interest from a savings account or money market account.

State and local taxes on CD and checking account interest

Most states tax interest income as part of your state income tax return. A few states — including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming — do not have a state income tax at all, so you owe no state tax on interest.

Other states tax interest at your regular state income tax rate, which varies by state and income level. Some states offer small exemptions or deductions for interest income, but most do not.

If you live in a city or county that collects local income tax (common in Ohio, Pennsylvania, and parts of other states), you may owe local tax on interest as well. Check your state and local tax authority websites for the rules in your area.

How to report interest income on your tax return

You report interest income on Schedule B (Interest and Ordinary Dividends) if you have more than $1,500 in interest and dividends combined. If you have less than $1,500, you can report the interest directly on Form 1040, line 1b.

List each source of interest separately on Schedule B if you have multiple accounts or CDs. The total goes to Form 1040, which feeds into your overall taxable income calculation.

If you received a 1099-INT, match the amount on the form to what you report on your return. If the amounts don't match, include a note explaining the difference — for example, if you withdrew a CD early and paid a penalty.

What happens if you don't report CD or checking account interest

The IRS receives a copy of every 1099-INT the bank sends you. If you don't report the interest on your tax return, the IRS will send you a notice asking why. This triggers an audit or a demand for payment, plus penalties and interest on the unpaid tax.

The penalty for not reporting income is typically 20% of the unpaid tax, plus interest that compounds daily. If the IRS determines you intentionally hid the income, the penalty can be higher — up to 75% in cases of fraud.

It is far simpler and cheaper to report the interest when you file. If you made a mistake in a prior year, you can file an amended return (Form 1040-X) to correct it.

Frequently Asked Questions

Do I owe tax on a CD if I haven't withdrawn the money yet?

Yes. You owe tax on the interest in the year it accrues, regardless of whether you withdraw the money or let it sit in the CD. The bank will report the interest on a 1099-INT, and you must report it on your tax return for that year.

What if my CD interest is less than $10?

The bank may not send a 1099-INT if interest is under $10, but you still owe tax on it. You are responsible for reporting all interest income to the IRS, even amounts below the 1099-INT threshold.

Can I deduct CD losses or penalties on my taxes?

You can deduct an early withdrawal penalty from your interest income, which reduces the taxable amount. However, you cannot deduct a loss if the CD's value declines — CDs are not subject to market losses. You can only deduct the penalty itself.

Do I owe tax on interest if I move to a state with no income tax?

You owe federal tax on all interest income regardless of where you live. You do not owe state income tax in states like Florida, Texas, or Nevada, but you still file a federal return and report the interest to the IRS.

What if the bank reports the wrong amount on my 1099-INT?

Contact the bank immediately and ask them to issue a corrected 1099-INT (marked as a correction). Once corrected, file your tax return with the correct amount. Keep a copy of the corrected form with your records in case the IRS questions the discrepancy.