The Early Withdrawal Penalty Tax Deduction on Your 2018 Tax Return
You Must File an Additional Schedule to Claim This Deduction
If you withdraw money from a certificate of deposit (CD) or other time-deposit savings account before your certificate matures, you'll probably have to pay a penalty. It's charged by the bank or financial institution, and it's withheld directly from your proceeds from the certificate of deposit.
But here's a bit of good news: This penalty on your early withdrawal of savings can be deducted on your tax return.
Why a Penalty?
Your CD deposit earns a certain amount of interest that's usually greater than that earned by a run-of-the-mill savings account. In exchange for this favorable interest rate, you must commit to leaving your money with the financial institution for a prescribed period of time. The bank will take back at least some of that "extra" interest if you pull out early, typically about six months' worth, but sometimes as much as a year's interest.
It's a set amount, provided for by your contract with the institution, and it's typically the same whether you take out $20 or $2,000. The penalty is deductible because it affects the amount of interest you earn.
Penalty Source Documents
You should receive a Form 1099-INT from the bank if you're subject to an early withdrawal penalty. The penalty will be reported in Box 2. The penalty is also reported in Box 2 of Form 1099-OID.
The total amount of interest your account earned will appear in Box 1, and you must include this on your tax return as well. You can deduct the penalty even if it's more than what appears in Box 1.
Where to Report the Penalty on Your Tax Return
This is where things get tricky in 2019. The early withdrawal penalty used to be reported on the front of your tax return on Line 30 of Form 1040. You had to file the long Form 1040 to claim this deduction for tax years through 2017 because this line item isn't found on the shorter Forms 1040A or 1040EZ.
Beginning with tax year 2018—the return you'll file in 2019—a whole new Form 1040 comes into play. It replaces the old 1040, as well as the 1040A and 1040EZ. The IRS and the Treasury Department revised Form 1040 to accommodate the changes made to the tax code made by the Tax Cuts and Jobs Act.
You'll still use Line 30, but you won't find it on the 1040 any longer. In fact, the new Form 1040 doesn't have a Line 30. Beginning with the 2018 tax year, when you file your return in 2019, you must enter this information on Line 30 of Schedule 1. You still don't have the option of filing Form 1040A or 1040EZ because those tax forms are now obsolete.
Don't worry—the deduction still has the same effect on your tax situation.
Possible Tax Impacts
The penalty for early withdrawal of savings is considered an adjustment to your income. This type of deduction reduces your adjusted gross income (AGI). Reducing your AGI reduces your taxable income and, by extension, lowers your tax.
Reducing your AGI has a ripple effort as well, impacting other parts of your tax return that are calculated based on your AGI. The net investment income tax, the child tax credit, and the itemized deduction for medical expenses, are all calculated based on your AGI.
Reducing your AGI can reduce your taxes directly by reducing your income, and it can also increase other deductions, increase other tax credits, or reduce other taxes.
An Important Distinction
This tax break applies only to penalties on regular savings, not the 10 percent tax penalty that can be assessed if you take withdrawals from some retirement savings plans before age 59 1/2.