A certificate of deposit is an agreement with a financial institution to leave money deposited for a specified period. A CD will usually produce a higher interest rate than a regular savings account because it assures the institution of having that money on deposit. CDs can be as short as 90 days or as long as 10 years, and the longer the term, the higher the interest will be. All that interest is taxable, however.
Taxable Interest Timing
You do not have to withdraw CD interest to have it be taxable. The Internal Revenue Service considers interest taxable either when it is paid or when it is credited to your account and could be withdrawn. That could be when the CD expires or periodically on longer-term CDs. Institutions that issue CDs are required to report taxable interest annually with a form 1099-INT.
You can defer paying taxes on CD interest if you set it up in an individual retirement account or some similar tax-deferred retirement plan. You'll still have to pay tax on the interest when you withdraw it, but you can defer that until you cash in the IRA, usually after age 59 1/2. That may qualify you for a lower tax rate on the interest.
CD Loan Interest
If you borrow money and secure the loan with a CD you have two tax considerations. You must report as taxable income any interest you receive or have credited to you from the CD. However, you can deduct interest on the loan, up to the amount of interest you received from the CD.
Maturities and Penalties
Interest on a CD that matures within a tax year must be reported as income, even if the CD is rolled over into another certificate immediately. Any money withdrawn from a CD before its expiration may be subject to a penalty, but you have to pay taxes on the total interest without deducting any penalty.