Series 7: 3.2.3.3.1 Original Issue Discount Bond

3.2.3.3.1  Original Issue Discount Bond

An original issue discount (OID) bond is one that is sold at 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 treated as interest, but most municipal bonds are tax-exempt, so no taxes are paid on it. If the discount is smaller than this minimum amount, the difference is ignored for tax purposes. 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 with an interest rate of 4% is issued at $900. This is an original issue discount bond whose discount 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,