Certain types of accounts offer incentives for leaving your money in the account for a specified period of time. For example, a bank CD rewards you with a higher interest rate for leaving your money on deposit for an extended period. The IRS gives you a tax break for investments held in your IRA. If you have to access the money in your account early, you might incur a penalty, which might or might not be tax-deductible.
Adjusted Gross Income
The IRS considers all income that is not exempted from taxation by law to be taxable. Your gross income includes both earned income -- such as wages, salary, tips, bonuses and commissions; and unearned income -- such as dividends and interest. Your taxable income is determined by subtracting your exemptions and either your standard deduction or itemized deductions from your adjusted gross income.
Individual Retirement Accounts
The IRS allows your investments in a traditional or Roth IRA to grow tax-deferred for as long as those investments remain in your IRA. If you tap your traditional IRA or the earnings portion of your Roth IRA before the account becomes qualified, you'll owe ordinary income taxes plus a 10 percent tax penalty on that distribution. The early withdrawal penalty on individual retirement accounts is not tax-deductible.
Other Qualified Plans
The IRS imposes an additional 10 percent tax penalty on early distributions from qualified retirement plans other than IRAs, such as a 401(k), 403(a), 403(b) or an eligible state or local government deferred compensation plan. The tax penalty is designed to discourage people from using their retirement money for other purposes. You can't deduct the 10 percent tax penalty on qualified retirement plans other than IRAs.
Early Withdrawal of Savings
When you purchase a certificate of deposit at your local bank or credit union, you must agree to leave your money on deposit for a set period of time. If you cash out your CD before it reaches maturity, the financial institution might charge an early withdrawal penalty. You must report the entire amount of interest you earned on that CD when you file your federal income taxes. As of the 2012 tax year you can deduct the amount of the early withdrawal penalty on Line 30 of Form 1040 as an adjustment to your income. You don't deduct the early withdrawal penalty from your adjusted gross income.
- Internal Revenue Service: Topic 558 - Tax on Early Distributions from Retirement Plans, Other Than IRAs
- Internal Revenue Service: Topic 557 - Tax on Early Distributions from Traditional and ROTH IRAs
- Internal Revenue Service: Form 1040 Instructions
- Internal Revenue Service: Topic 403 - Interest Received
- Internal Revenue Service: Publication 550, Penalty on Early Withdrawal of Savings.
- Internal Revenue Service: Retirement Plans FAQs Regarding IRAs
- New York State Society of CPAs: Assessing Your Adjusted Gross Income
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.