If you have purchased a CD — otherwise known as a certificate of deposit — from your bank, you probably know that withdrawing money from it before the term expires usually requires payment of a penalty.
However, you might not realize that this fee you pay for an early withdrawal, which typically amounts to a few months of interest, can be deducted on your federal tax return.
The IRS allows you to deduct the cost of such penalties that are reported on Form 1099-INT or 1099-OID, an annual tax form that you would receive from the bank or other financial institution to which you paid the early-withdrawal penalty.
The value of this tax perk might be relevant to fewer people this tax season than in the past few years. The U.S. Federal Reserve steadily increased its target federal funds rate multiple times in 2022 and 2023, resulting in higher interest rates on new CDs.
But after the rate drops in 2024 and 2025, interest rates are trending lower. That likely means fewer folks bought CDs — a popular strategy when rates were skyrocketing — than in previous years. Rates are still reasonable though.
Some investors may have cashed out early last year to shift funds or free up liquidity. Others may have cashed in CDs early to help cover rising costs due to inflation.
With tax season upon us, it’s wise to look for deductions anywhere you can.
Anyone who paid such early withdrawal fees should deduct them on their federal return.
Now, it’s important to remember that a deduction helps you get some, but not all, of your money back.
Unlike a tax credit, which decreases the tax you owe dollar for dollar, a deduction only reduces your taxable income. Essentially, that means the value of a deduction depends on your tax rate.
As we have previously explained:
“Say your tax rate is 22%. A $100 deduction could lower your taxable income by $100, and that in turn could lower your tax bill by $22 (22% of the $100 deduction).”
Still, a deduction can ease some of the pain of paying an early withdrawal penalty on a CD.
Looking for more ways to trim your upcoming tax bill? Check out “12 Tax Deductions You Can Claim Even If You Don’t Itemize.”
