How to Report an OID Adjustment on Your Tax Return
The OID income reported on your tax form isn't always the correct taxable amount. Learn when an adjustment is necessary to ensure tax reporting accuracy.
When an investor buys a debt instrument like a bond for less than its face value, the discount has tax implications. This Original Issue Discount (OID) is the difference between the bond’s stated redemption price at maturity and its lower issue price, representing a form of interest income. This income is taxable each year the investor holds the bond, even if the cash is not received until maturity. This annual recognition prevents the deferral of taxes on interest earned over the bond’s life.
Understanding Form 1099-OID
Investors receive Form 1099-OID, “Original Issue Discount,” from the institution holding their debt instruments if the OID for the year is $10 or more. This form details the OID income that must be reported for the tax year, and a copy is also sent to the IRS.
Box 1 shows the “Original issue discount for the year,” which is the portion of the OID considered taxable income. Box 2, “Other periodic interest,” reports any additional, non-OID interest paid during the year, which is also taxable.
For investors with federal government debt, Box 8 reports the “Original issue discount on U.S. Treasury obligations.” This OID is subject to federal income tax but is exempt from state and local income taxes. This distinction requires careful handling on tax returns.
Determining if an OID Adjustment is Necessary
The OID amount in Box 1 of Form 1099-OID is not always the correct amount to include in taxable income. An adjustment is necessary if the reported OID is incorrect due to specific circumstances, and failing to make one can lead to an overpayment of taxes.
The most common reason for an adjustment is purchasing a bond at an “acquisition premium.” This occurs when an investor buys a bond for a price higher than its adjusted issue price but less than its stated redemption price. This premium can be amortized over the bond’s remaining life to reduce the OID reported as income each year.
An adjustment may also be needed if you did not own the bond for the entire year, which requires prorating the reported OID. This often happens when a bond is bought or sold between interest payment dates. Specific rules that can require adjustments also apply to other debt instruments, like stripped bonds or inflation-indexed securities.
Tax-exempt OID from sources like municipal bonds is not included in taxable income but still affects the bond’s cost basis. The basis increases by the accrued tax-exempt OID each year. This adjustment is necessary for correctly calculating capital gains or losses when the bond is sold.
Calculating Your Correct OID Amount
A taxpayer may need to calculate the correct OID amount to report. IRS Publication 1212, “Guide to Original Issue Discount (OID) Instruments,” provides the detailed rules needed to figure the proper adjustment.
If you paid an acquisition premium, your broker might calculate the amortization for the year and report it in Box 6 of Form 1099-OID. This amount reduces the OID you must report as income.
If this information is not on your form, you must calculate the adjustment yourself using the methods in IRS Publication 1212. The calculation is based on the bond’s yield at the time of purchase. Keep detailed records of these calculations to substantiate the adjustment on your tax return.
Reporting the OID Adjustment on Your Tax Return
Once the correct OID amount is calculated, it must be reported on Schedule B (Form 1040), “Interest and Ordinary Dividends.” This process involves showing the adjustment on the form, which clarifies why your reported income differs from the amount on Form 1099-OID.
On Part I of Schedule B, report the full OID amount from Box 1 of Form 1099-OID on line 1, along with the payer’s name. After listing all interest and OID from all sources, enter a subtotal.
Directly below this subtotal, record the adjustment. Write a description like “OID Adjustment” and enter the calculated premium amortization as a negative number. This amount represents the reduction to the reported OID.
Finally, subtract this negative adjustment from the subtotal of all reported interest and OID. The resulting net figure is the correct amount of taxable interest income. This adjusted total is then carried to the appropriate line on Form 1040.