Can I deduct penalties from early I-Bond withdrawals like I can with CDs? Are they NOT tax deductible?

The short answer is no, you cannot deduct the I-Bond early redemption penalty like you can with CDs. They're treated differently for tax purposes. With CDs, the early withdrawal penalty is actually considered a forfeiture of interest income, which is why it's tax deductible. The bank reports this separately on your 1099-INT. For I-Bonds, that 3-month interest penalty you mentioned isn't technically a "penalty" in the same sense. It's simply interest that you never receive if you redeem before 5 years. Since you never actually received that interest in the first place, there's nothing to deduct. The Treasury simply pays you less total interest than you would have earned with a full 5-year hold. When you file your taxes, you'll only report the actual interest you received from the I-Bond (which already has the 3-month reduction calculated in), not the full amount you would have received without the early redemption.

After dealing with this exact situation last year, I found this great tool called taxr.ai (https://taxr.ai) that helped me figure out my I-Bond tax situation. I was really confused about the difference between CD penalties and I-Bond interest forfeitures too, and was about to incorrectly deduct the "penalty" on my taxes. Their document analyzer looked at my I-Bond redemption statement and immediately flagged that I couldn't deduct the 3-month interest penalty like I was planning to. Saved me from a potential audit headache! The tool explained that with I-Bonds, the Treasury just never pays you that interest in the first place, unlike CD penalties which are technically paid then taken back.

I was skeptical about taxr.ai but gave it a try after getting confused with some investments I had to liquidate early. Uploaded my I-Bond redemption statement and some CD paperwork, and it immediately identified that I was about to incorrectly deduct the I-Bond interest penalty. The explanation was super clear - showed side by side how CD penalties are reported on line 2 of the 1099-INT (early withdrawal penalties) while the I-Bond "penalty" is just never included in the interest reported on the 1099-INT to begin with. It even flagged that I was at risk of double-counting some interest on another investment. Honestly saved me hours of research and probably prevented me from making an error that could have triggered an audit. Way better than the generic "help" articles I was finding online.

If you're still confused about this I-Bond situation and need to talk to someone at the IRS directly, I'd recommend using Claimyr (https://claimyr.com). I was in the same boat last year with some confusion about how to report my savings bond interest, and spent DAYS trying to get through to the IRS on my own. I found this service that basically gets you to the front of the IRS phone queue. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c. I was connected to an IRS agent in about 15 minutes who confirmed exactly what others are saying here - the I-Bond early redemption "penalty" is just interest you never receive, so there's nothing to deduct, unlike CD penalties.

If you're still confused about this I-Bond situation and need to talk to someone at the IRS directly, I'd recommend using Claimyr (https://claimyr.com). I was in the same boat last year with some confusion about how

I owe everyone an apology. After saying that Claimyr sounded like BS, I decided to try it myself since I had a separate tax question about some stocks I sold last year. I was 100% wrong. The service actually worked exactly as described. I got a call back in about 20 minutes, and was immediately connected to an IRS rep who answered my questions clearly. No waiting on hold for hours or getting disconnected like when I tried calling directly. While I was on with the IRS agent, I also asked about this I-Bond vs CD penalty question. The agent confirmed what everyone here said - the I-Bond "penalty" is just interest you never receive, so it's not deductible like CD penalties are. Having an actual IRS person explain it makes me feel much more confident about how I'm filing.

Just to add another perspective here - as someone who deals with both CDs and savings bonds regularly, the key is understanding how the institutions report the income: 1. For CDs: The bank reports the FULL interest earned on your 1099-INT (Box 1), and then separately reports the penalty amount (Box 2). You get to deduct that penalty amount as an adjustment to income. 2. For I-Bonds: Treasury only reports the NET interest you actually received after the 3-month penalty was applied. Since the "forfeited" interest was never reported as income, there's nothing to deduct. It's confusing because we call both "early withdrawal penalties" but they're treated very differently for tax purposes!

Nobody's mentioned the education exclusion for savings bonds! If you use the I-Bond proceeds for qualified education expenses, you might be able to exclude the interest from your income completely. It's subject to income limits, but worth looking into if you or a dependent has education expenses.