If you withdraw money early from a certificate of deposit (CD) or certain interest‑bearing savings accounts, your bank or financial institution may charge an early withdrawal penalty. While this penalty can reduce the amount you receive, it is often deductible on your federal tax return.
🏦 What Is an Early Withdrawal Penalty?
An early withdrawal penalty is a fee charged by a bank or financial institution when funds are withdrawn from a CD or other time‑deposit savings account before the maturity date.
✅ The penalty usually represents interest you must give up
✅ In some cases, it may reduce principal
✅ The IRS does not impose it
The terms of your account agreement with the financial institution determine this penalty.
📄 Where You’ll See the Penalty Reported
If you paid an early withdrawal penalty, it is typically reported on one of the following forms issued by your bank:
🧾 Form 1099‑INT
- Box 1 – Total interest earned
- Box 2 – Early withdrawal penalty
🧾 Form 1099‑OID
- Box 3 – Early withdrawal penalty
⚠️ Important:
All interest shown on the form must still be reported as income, even if some or all of it was forfeited due to the penalty.
🚫 Not the Same as a Retirement Account Penalty
💸 How the Penalty Is Treated on Your Tax Return
The early withdrawal penalty is:
✅ Deductible as an adjustment to income
✅ Reported on Schedule 1 of Form 1040
✅ Used to reduce Adjusted Gross Income (AGI)
✅ Allowed even if you don’t itemize deductions
✅ Allowed even if the penalty is more than the interest earned
This means the deduction can help lower your taxable income, even if the penalty exceeds your interest income.
🧮 Example
A taxpayer breaks a CD before it matures:
- 💵 Interest earned (Form 1099‑INT, Box 1): $300
- ❌ Early withdrawal penalty (Box 2): $450
✅ How it’s reported:
- Report $300 as interest income
- Deduct $450 as an adjustment to income on Schedule 1
➡️ The full penalty is deductible, even though it exceeds the interest earned.
What if I can't save my 1099-INT because box 2 is greater than box 1?
If your 1099-INT's box 2 is greater than box 1, you will receive an error when trying to save the 1099-INT. To resolve this, remove the early withdrawal penalty amount from box 2 and save the 1099-INT. After the 1099-INT is saved, follow the steps below to enter the early withdrawal penalty.
- Federal
- Deductions (Select my forms)
- Adjustments to Income
- Penalty on Early Withdrawal of Savings or Certificate of Deposit (CD)