Original Issue Discount (OID) Bonds
An original issue discount (OID) bond is one that is sold at a discount of face value. The discounted price of the bond substitutes for periodic interest payments, since the full principal will be delivered at maturity. The difference between the face value of the bond and the issue price is the original issue discount. If the discount equals or exceeds a certain minimum amount, it is reported as income over the life of the bond. If the OID is smaller than this minimum amount, the bond is treated, for tax purposes, as if it had been issued at par, with no interest earned. However, if the OID bond is held to maturity, the de minimis amount will be treated as a capital gain.
The IRS sets this de minimis amount at 0.25% of par per year, between the time of acquisition and the bond’s maturity.
Example: A 20-year bond is issued at $900. This is an original issue discount bond whose OID is $100. If the OID is less than the de minimis amount, it will be treated as too negligible to count for tax purposes. For this bond, the de minimis amount is (0.25% x $1,000 x 20 years) = $50. Since the original issue discount of $100 exceeds this amount, the discounted amount is reportable as interest income.
Ordinarily, investors in a discounted bond pay income taxes on the OID as if periodic interest payments were being made. Taxes are paid on the accretion to par over the life of the bond, a way of accounting for t