The Penalty on Early Withdrawal of Savings or Certificate of Deposit (CD) is a fee charged by a bank or financial institution when funds are withdrawn early from a CD or other time‑deposit savings account.
✅ This penalty is deductible as an adjustment to income on the federal tax return.
🚫 This is not the same as the 10% early distribution penalty for retirement accounts reported on Form 1099‑R.
The two penalties are treated completely differently for tax purposes.
📄 Where the Penalty Is Reported
The early withdrawal penalty may appear on interest income forms issued by the financial institution:
- 🧾 Form 1099‑INT
- Box 2 – Early Withdrawal Penalty
- 🧾 Form 1099‑OID
- Box 3 – Early Withdrawal Penalty
✅ These amounts represent interest or principal forfeited due to early withdrawal.
✅ The full interest income must still be reported.
💰 Tax Treatment
- ✅ Deductible as an adjustment to income
- ✅ Reduces Adjusted Gross Income (AGI)
- ✅ Allowed even if the penalty exceeds interest earned
- ✅ Available without itemizing deductions
📍 Reported on Schedule 1 – Penalty on Early Withdrawal of Savings. [cacrm.github.io]
🧭 TaxSlayer Entry Methods
TaxSlayer supports two correct entry paths.
✅ Method 1: Enter Through Interest Income
Use this method when the penalty appears on a 1099‑INT or 1099‑OID.
📍 Navigation Path
Federal Section
→ Income
→ Did you earn any interest or dividend income from a bank, brokerage firm, or some other financial institution?
→ Interest Income (Form 1099‑INT)
- Enter Box 1 (interest income)
- Enter Box 2 (early withdrawal penalty)
✅ TaxSlayer will automatically:
- Report full interest as income
- Deduct the penalty as an adjustment to income
- Flow the deduction to Schedule 1
For Form 1099‑OID:
- Enter Box 3 – Early Withdrawal Penalty
- TaxSlayer handles the deduction automatically
✅ Method 2: Manual Adjustment Entry
Use this method only if:
- The penalty comes from a Schedule K‑1, or
- The penalty is not reported on a 1099‑INT or 1099‑OID
📍 Navigation Path
Federal Section
→ Deductions
→ Adjustments
→ Penalty on Early Withdrawal of Savings or Certificate of Deposit (CD)
- Enter the penalty amount directly
- Amount flows to Schedule 1
📌 Example
A taxpayer breaks a CD early:
- 💵 Interest earned (1099‑INT Box 1): $300
- ❌ Early withdrawal penalty (Box 2): $450
✅ Reporting:
- Report $300 as interest income
- Deduct $450 as an adjustment to income
➡️ The penalty may exceed interest earned and is still deductible.
🚫 Common Error
🚫 Do NOT confuse this with:
- IRA, 401(k), or pension withdrawals
- Form 1099‑R
- The 10% early distribution penalty
✅ CD/savings penalties:
- Charged by banks
- Deductible
- Reported on Schedule 1
✅ Retirement penalties:
- Imposed by IRS
- Additional tax
- Reported on Schedule 2