4.16 Forfeiture of Interest on Premature Withdrawals

Banks usually impose an interest penalty if you withdraw funds from a savings certificate before the specified maturity date. You may lose interest if you prematurely withdraw funds in order to switch to higher paying investments, or if you need the funds for personal use. In some cases, the penalty may exceed the interest earned so that principal is also forfeited to make up the difference.

If you are penalized, you must still report the full amount of interest credited to your account. However, on Form 1040, you may deduct the full amount of the penalty, forfeited principal as well as interest. The deductible penalty amount is shown in Box 2 of Form 1099-INT sent to you. You may claim the deduction even if you do not itemize deductions. On Form 1040, enter the deduction on Line 30, marked “Penalty on early withdrawal of savings.”

Caution

CD Early Withdrawal

If you are penalized for making an early withdrawal from a certificate of deposit, you may lose part of your interest or principal. You must report the full amount of interest credited to your account, but you may deduct the full amount of the penalty(whether forfeited principal or interest) on Line 30 of Form 1040.

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Loss on redemption before maturity of a savings certificate.

If you redeem a long-term (more than one year) savings certificate for a price less than the stated redemption price at maturity, you are allowed a loss deduction for the amount of original issue discount (OID) reported as income but not received. The deductible amount is shown in Box 3 of Form 1099-OID. Claim the deduction on Line 30 of Form 1040. The basis of the obligation is reduced by the amount of the deductible loss.

Do not include in the computation any amount based on a fixed rate of simple or compound interest that is actually payable or is treated as constructively received at fixed periodic intervals of one year or less.