When is a CD's interest taxed?

George Saenzq_v2.gifDear Tax Talk,
I bought a CD in January of 2008 that matured one year later, on Jan. 29, 2009. My bank sent a 1099 for a portion of the interest in 2008 and said I would receive another 1099 for the balance of the interest at the end of 2009. I never took interest from this account until the maturity date, at which time I closed the CD and took both the principal and interest.

The reason I bought a 12-month CD in the first place was so that I could show the income from it in 2009, not 2008. It was a rather large CD. The IRS refers me to Publication 17, page 60, but the bank says they have a right to send me a 1099 in both years because they paid the interest into the account and then compounded it monthly, and they can quote no IRS rule to substantiate that. I am so confused. Can you help me?
-- Nancy

a_v2.gifDear Nancy,
As we're learning, the best laid plans of mice and men don't matter to the banks. In general, any interest that you receive or that is credited to your account and can be withdrawn is considered taxable income. (It does not have to be entered in your passbook.)

The following information from IRS Publication 550 says that some bank accounts call for the deferral of interest until maturity, such as a Certificate of Deposit or other type of deferred-interest account. If you open any of these accounts, interest may be paid at fixed intervals of one year or less during the term of the account.

You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in one year or less and pay interest in a single payment at maturity. If interest is deferred for more than one year, the interest can be imputed under the original issue discount rules -- imputed means that the payments can be recharacterized.

Since the bank has already issued a 1099-INT for the amount of interest it believes you were entitled to in 2008, you need to persuade them differently. You would have to argue with the bank that you were not entitled to the monthly accrued interest until maturity without incurring a substantial penalty. You will need to convince the bank to reissue the 1099-INT if you can persuade them that you are correct under the law.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.


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