You are not subject to the IRA interest tax on the interest your IRA accrues while they remain in your account. Instead, you'll be responsible for paying any IRA interest taxes when you receive traditional IRA distributions. Distributions from a traditional IRA are subject to full or partial taxation in the year of distribution. To determine if your IRA is taxable, see Is the distribution of my traditional IRA, SEP or SIMPLE, subject to tax? If you only made deductible contributions, the distributions are fully taxable.
Use Form 8606 to calculate the taxable portion of withdrawals when the traditional IRA contains non-deductible contributions. If you contribute to a traditional IRA, you can usually cancel that contribution when you file your federal income tax return. Roth IRAs enjoy tax-deferred growth on investment income generated by their contributions, making them similar to traditional IRAs in that regard. Contributions to a Roth IRA are not deductible (and you don't report the contributions on your tax return), but distributions that are qualified or are a tax return are not subject to taxation.
The government charges a 10% penalty, in addition to any ordinary income tax due, for early withdrawals from a traditional IRA, and a state tax penalty may also apply. If you made non-deductible contributions to a traditional IRA, you must attach Form 8606, Non-Deductible IRAs. Regardless of how your traditional IRA investments grow, whether from interest income, dividends, or capital gains, that growth is not subject to current taxes as long as those funds remain within your IRA. All withdrawals from your traditional IRA are taxed as ordinary income, regardless of how those funds come into your IRA.
There is no option to withdraw tax-exempt funds from your traditional IRA, even if the interest earned on a financial product held in your IRA is exempt from tax. A traditional IRA is an individual retirement account that you can contribute money to before or after taxes, giving you immediate tax benefits if your contributions are tax-deductible. When you violate the Roth IRA rules, there is a situation where you may need to declare the interest of a Roth IRA on your taxes.