I interpret it to mean that if you earned interest on an account and it is OK to take advantage of that earned interest without paying a penalty for early withdrawal -- even if you didn't withdraw the earned interest -- then you need to declare it as income for the year in which it was earned.
Perhaps the financial institution in which you earned the interest would issue a 1099-INT if you withdrew interest from the account. Therefore you would be complying with the regulation and you would be able to properly declare the interest withdrawn in the current tax year since you'd have the 1099-INT.
But if you did not withdraw the earned interest I don't believe the financial institution would issue a 1099-INT (?). Therefore you would not have a 1099-INT to cover the interest since it wasn't withdrawn. You'd have to create some sort of substitute 1099-INT............. Which would be awkward.
The regulation is not worded well enough to be adhered to.
