Certificates of deposit offer you a fixed interest rate for a predetermined time period, so you know how much you're going to make. When the taxes are payable depend on the term of the CD because the Internal Revenue Service treats CDs with a maturity of longer than one year different than CDs that mature in a year or less.
CD Taxable Income Basics
When you take out a CD, you put in a certain amount of money. When it matures, you receive all of the money you put in plus the interest. For tax purposes, only the interest portion of the payment is taxable, because you've already paid taxes on the principal portion when you earned it, either from working or other investments. For example, say you put $5,000 in a CD. When it matures and you receive $5,150, the first $5,000 of that isn't taxable income. Only the $150 of interest is taxable.
If you have a CD that matures in less than one year or that pays you the interest at fixed intervals of one year or less, you report the interest income in the year the CD matures because that's the first time you have the opportunity to access the money without paying a substantial penalty. If you had taken out the money earlier, you would owe an early-withdrawal penalty. For example, say you take out a CD that matures in six months Nov. 1, 2013. Because you can't access any of the interest until the maturity May 1, 2014, all the interest income counts on your 2014 return.
If you have a CD that matures in more than one year, you must prorate the interest you're going to receive over each year of the CD. Then, when the CD matures, you only report the portion of the interest that you have yet to include in your taxable income. For example, say you take out a two-year CD on Jan. 1, 2013 so it will mature on December 31, 2014. You report half the interest income you're earning on your 2013 return and half on your 2014 return.
Interest income is taxed at your ordinary income tax rates, regardless of the length of your CD's term. It will never qualify for the lower long-term capital gains rates. For example, if you fall in the 25 percent tax bracket and have $1,000 of interest income from your CD, you pay $250 in federal taxes. Your interest income from CDs also might be subject to the net investment income tax -- a 3.8 percent additional tax -- if your income exceeds the annual thresholds. As of 2013, you're hit with the tax on your CD interest income if your modified adjusted gross income exceeds $250,000 if you're married filing jointly, $200,000 if you're single or $125,000 if you're married filing separately.
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