What can of tax deduction can you get for early CD withdrawal?
There is a special tax deduction available when a taxpayer incurs a penalty for an early withdrawal from a certificate of deposit (CD). First, it is important to remember that taxpayers must include in income the full amount of interest earned on the CD during the year of the premature withdrawal.
Deduction on Penalty for premature withdrawal from certificate of deposit
However, if there is an early withdrawal from the CD, the taxpayer will get a deduction for the amount of the premature withdrawal penalty. The bank is required by the IRS and will provide you with a Form 1099-INT that reports both of these figures.
Early CD Withdrawal Form 1099-INT
It is possible that the bank will deduct the penalty for cashing the CD early from the proceeds it credits to you, for tax purposes, the interest and penalty amounts are separate, and have to be reported separately on your return according to the information on the Form 1099-INT.
You may not net the penalty and interest against each other and report only the net amount on your tax return. There is a good chance that the penalty might even exceed the interest earned.
The deduction a taxpayer gets for the premature CD withdrawal penalty is “above-the-line.” This is very favorable for taxpayers because you get to take it regardless of whether you itemize your deductions. Furthermore, it is not subject to the 2%-of-adjusted-gross-income limit that effectively reduces your “miscellaneous itemized deductions.”
Penalty for Early CD Withdrawal
If the penalty is a large amount, you may want to consider changing the withholding on your wages. The deduction you get for the premature CD withdrawal penalty will be considered an “adjustment” to your income.
It is possible to use this to reduce the federal income taxes withheld from your wages for the year of the premature withdrawal. You will have to change your W-4 and indicate that there is an adjustment to your income. This is probably only necessary if the penalty is a significant portion of your income.