Think back. Remember when CD rates hit historic highs? Oh wait, that was only weeks ago — before the Federal Reserve hinted that it would drop the federal funds rate, and banks lowered the amount they paid on CDs in anticipation.
While the days of high APYs may be behind us (for now), it’s essential to plan for the taxes you’ll owe on any money you’ve earned on CDs thus far this year.
Fortunately, there’s good news:
- You were able to take advantage of CD rates at their peak.
- Figuring out how much you’ll owe in taxes, though a little tricky, is eye-opening.
- Although CD rates have slipped, it’s not too late to snag a higher-than-typical rate before they drop more.
How CDs are taxed
Interest income, like any money you earned on CDs this year, is taxed at the same rate as ordinary income. To determine how much you’ll owe, you’ll need to know your marginal and effective tax rates. If those phrases are unfamiliar to you, stick with us here. The way it breaks down is pretty interesting (and once you understand how it works, it is quite simple).
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Step 1: Calculate your adjusted gross income (AGI)
- Add all income sources, including wages, capital gains, tips, commissions, and bonuses.
- Subtract your income tax deductions, like contributions to pre-tax retirement accounts or health savings accounts (HSAs).
- The number you end up with is your adjusted gross income (AGI).
To see how this works, let’s look at an example.
- Sam earns $50,000 from all income sources, including $500 in CD interest.
- Sam contributes $5,000 (10%) of their income to a pre-tax retirement account.
- Sam’s AGI is $45,000 ($50,000 – $5,000).
Step 2: Calculate your taxable income
When filing your tax return, you have the option of taking the standard deduction or itemizing your deductions. Most Americans opt for the standard deduction, the amount of which varies based on your filing status. Whatever the amount you plan to deduct, subtract it from your AGI to find your taxable income.
Let’s go back to our example.
- Sam’s AGI is $45,000
- Sam is a single tax filer, so they’re eligible for a standard deduction of $14,600.
- Sam subtracts the standard deduction from their AGI to arrive at their taxable income: $45,000 – $14,600 = $30,400
Step 3: Find your marginal tax rate
Now that you have your taxable income, you can find your marginal tax rate, which some refer to as their “tax bracket.” That term can be a little misleading, though, as most people’s taxable income falls into several brackets, which are taxed at different rates.
| Tax rate | Single Filers | Married Couples Filing Jointly | Married Couples Filing Separately | Head of Household |
|---|---|---|---|---|
| 10% | $11,600 or less | $23,200 or less | $11,600 or less | $16,550 or less |
| 12% | $11,601 to $47,150 | $23,201 to $94,300 | $11,601 to $47,150 | $16,551 to $63,100 |
| 22% | $47,151 to $100,525 | $94,301 to $201,050 | $47,151 to $100,525 | $63,101 to $100,500 |
| 24% | $100,526 to $191,950 | $201,051 to $383,900 | $100,526 to $191,150 | $100,501 to $191,150 |
| 32% | $191,951 to $243,725 | $383,901 to $487,450 | $191,151 to $243,725 | $191,151 to $243,700 |
| 35% | $243,726 to $609,350 | $487,451 to $731,200 | $243,276 to $365,600 | $243,701 to $609,350 |
| 37% | $609,351 or more | $731,201 or more | $365,601 or more | $609,351 or more |
Data source: Internal Revenue Service.
Because Sam is a single filer and their taxable income is $30,400, their marginal tax rate is 12%. That doesn’t tell the whole story, though, because Sam only pays that rate on some of their income.
We want to find the overall percentage we’re paying on all our income — also known as our effective tax rate.
Step 4: Find your effective tax rate
To find out how much you’re actually paying in income tax, you need to add up the amount you’re paying on income in each bracket. You can then divide that amount by your taxable income to find your effective tax rate.
- Going by the 2024 tax brackets, Sam would pay 10% on their first $11,600 in taxable income, or $1,160.
- They would pay 12% on the remaining $18,800 ($30,400 – $11,600), or $2,256.
Sam owes $3,416 in taxes ($1,160 + $2,256), giving them an effective tax rate 11.2% ($3,416 / $30,400).
Finally, figuring out taxes due
Imagine that Sam had put $10,000 into a 12-month CD. The CD offered an APY of 5%, and by the time it matured this year, Sam had earned $500 (which is included in their taxable income).
Because Sam’s effective tax rate is 11.2%, they’ll effectively pay $56 in taxes on the money the CD earned ($500 x 11.2% = $56).
I use the word “effectively” because it’s not as if the government hands you a tax bill for every bit of income you earn from every source. It’s all lumped together, and the total, minus deductions, determines the tax rate you pay.
How to report CD income
By the time you file your 2024 tax return, your financial institution should have sent you a 1099-INT statement showing how much you earned on your CD for the year. You’ll include the interest shown on your 1099-INT on Form 1040, Line 2b of your federal income tax return.
If you opened a multi-year CD, your financial institution will generally report interest in increments at the end of each year the CD remains open. For example, if you opened a 5-year CD in 2024, you should receive a 1099-INT by the time you’re ready to file your 2024 taxes. You’ll then receive another statement when it’s time to file 2025 taxes, and so on.
Whether you deposit the interest earned on your CD in a high-yield savings account or roll it over into another CD while rates remain reasonably high, a CD is one more dependable tool in your financial arsenal.
