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Withdrawal of Savings or Certificate of Deposit (CD) is a fee charged by a bank or financial institution when funds are withdrawn early from a CD or other time‑deposit savings account.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.
Entry Methods
Our software 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)
The program 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
- The program 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