Note: Tax laws are constantly changing, so please always check with a CPA or accountant to determine the latest laws regarding cd income taxation.
CD Tax Questions: Introduction
CDs are one the safest investments available these days. Investors deposit their money in banks and credit unions, and the financial institutions pay investors back with interest on their principle investments. No wonder so many people are choosing CDs as one of their primary investments. There is a downside to earning interest on investments. Investors must pay taxes on the interest that they earn each year. It is very important that investors have a clear understanding of CDs and taxes to prevent problems during tax season.
Certificate of Deposit CD Tax Liabilities-State and Federal Taxes (Brief Overview)
Earning interest on CDs can be quite exciting, but investors should expect to pay state and federal taxes on their earnings. As long as investors earn more than $10 in interest, they must pay taxes on their earnings. The issuers send investors a 1099-INT at the end of the year that reflects the amount of interest their CD accounts earned for the current year. Sometimes issuers do not send these documents to investors, but they are still expected to report this information to their tax preparer during tax time, and they still must pay taxes on this amount.
Some investors may opt to accrue interest on their investments until the CDs mature. Investors should not think that this would prevent them from paying taxes each year on their earnings. Even though they do not have the money in their savings or checking accounts, they are still expected to pay taxes on the accrued interest. The issuer should also send investors a 1099-INT that reflects their interest earned so far. Again, they may not receive this document from the issuer, but they still must report this information to their tax preparer.
People who receive CDs from someone’s death, or they become the guardian of someone who is mentally incompetent must still pay taxes on the interest earned on their CDs. Once they provide information to the issuer as proof that they are the guardian or new owner of the CDs, they can take control over the accounts and pay taxes on their CDs. In some cases, the estates may pay the taxes on the CDs for people who receive the CDs upon death of the original owner, but if they do not, investors must pay the taxes.
Investors do not have to pay taxes on their CDs in certain situations. IRA CDs are tax deferred until investors pull out their money. Investors do not have to worry about paying hefty taxes on money in which they cannot currently spend the principle or interest.
Tips on Paying Taxes on Certificate of Deposit CD Interest Earnings
- Consult with a tax professional before tax season. Investors may not know about various tax breaks that can save them money when they have their taxes prepared. Tax professionals can also provide investors with other information that can earn them more money during tax time.
- Investors should pay taxes even when they do not receive the 1099-INT. Trying to get over on the government is not a good idea. It is in their best interest to report their interest earning even if they do not get documentation from the issuer of the CDs. If the government ever decides to audit investors’ tax information, investors may have to pay higher taxes on their earnings. They may use a marginal tax rate to tax the interest, even if the rate is higher than their current tax level of income. For example, a portion of their income may be taxes at 10% and another portion may be taxes at 25%. Investors may have to pay the taxes on their CDs based on their highest level of income as a penalty.
- Investors may receive a tax break on CD withdrawals. Withdrawing money from CDs and closing CD accounts can cost investors very expensive fees. These fees can be reported at tax time, and investors may receive a break on the taxes that they owe. Investors should talk to their tax professional to determine how to file those fees on their taxes.
- Invest in tax sheltered CDs to prevent taxes until withdrawal. Traditional IRA CDs provide investor with a tax break that can save them money.
It is impossible to escape paying taxes. Even investments that investors receive as gifts from loved ones are not protected from taxes. It is not a good idea to try to evade paying taxes because it may cause investors a great deal of money once the time comes for the government to get involved. Investors should choose investments wisely and always pay taxes on their investments.