How to Report Tax-Exempt OID on Form 1040

Understanding how to properly report all income, even if not taxed at the federal level, is an important part of tax compliance. This article explains tax-exempt Original Issue Discount (OID), why it must be reported, and the steps for gathering information and accurately reporting it on your federal income tax form. Accurately accounting for all income helps ensure the accuracy of your tax filings and can impact various calculations on your return.

Understanding Tax-Exempt Original Issue Discount

Original Issue Discount (OID) refers to a type of interest that arises when a debt instrument, such as a bond, is initially sold for a price lower than its stated redemption price at maturity. This difference between the issue price and the maturity value is considered a form of interest that accrues over the life of the bond, even if no cash payments are made until maturity. For instance, if a bond with a $1,000 face value is sold for $900, the $100 difference is the OID.

Tax-exempt OID applies to OID generated by debt instruments whose interest income is exempt from federal income tax. Municipal bonds, issued by state and local governments to finance public projects, are common examples. While interest on these bonds is typically free from federal income tax, and often state and local taxes if issued within your state of residence, it still needs to be reported.

Reporting tax-exempt OID on a federal tax return is necessary for several reasons, despite its federal tax-exempt status. It allows the Internal Revenue Service (IRS) to track income and ensure compliance. This income can also affect the calculation of Modified Adjusted Gross Income (MAGI), which may influence the taxability of Social Security benefits. Tax-exempt OID also helps determine the accurate basis of a bond, crucial for calculating any gain or loss upon its sale or maturity.

Additionally, while federally exempt, tax-exempt OID may be subject to state or local income taxes, depending on the bond’s issuer and the taxpayer’s state of residency. Some municipal bonds, particularly private activity bonds, might also be subject to the Alternative Minimum Tax (AMT).

Gathering Information for Reporting

The primary document for identifying tax-exempt OID is Form 1099-INT, Interest Income, or Form 1099-OID, Original Issue Discount, which financial institutions or brokers send to investors. Specifically, Box 8 of Form 1099-INT reports tax-exempt interest, which can include tax-exempt OID. For tax-exempt OID on obligations acquired on or after January 1, 2017, the amount is found in Box 11 of Form 1099-OID. Box 11 shows the tax-exempt OID for the portion of the year you owned the obligation.

The amount in these boxes represents the accrued OID for the tax year, which is treated as tax-exempt interest for federal income tax purposes. If you hold multiple tax-exempt OID bonds, consolidate the amounts from all relevant Forms 1099-INT and 1099-OID received.

If a Form 1099-INT or 1099-OID is not received, you are still obligated to report the income. In such cases, consult your brokerage statements, bond confirmations, or contact the bond issuer directly to determine the exact amount of tax-exempt OID accrued during the tax year. Financial institutions are required to report tax-exempt interest, including OID, but you remain responsible for accurate reporting even without a form.

Reporting Tax-Exempt OID on Form 1040

Once you have identified the precise amount of tax-exempt OID, the next step involves reporting it on your federal income tax return. This amount is reported on Form 1040, U.S. Individual Income Tax Return, and often requires the use of Schedule B, Interest and Ordinary Dividends.

You will first need to include the total tax-exempt OID on Schedule B (Form 1040), Part I, Line 1. This line is generally for all taxable interest, but the instructions for Schedule B clarify that tax-exempt interest, including tax-exempt OID, should also be listed here for informational purposes. If you received tax-exempt stated interest in addition to OID, such as from Box 8 of Form 1099-INT, those amounts are also included in this total. When listing the payer, if a brokerage firm provided a Form 1099, you should list the brokerage firm.

After entering the details on Schedule B, the total tax-exempt interest from all sources, including tax-exempt OID, is carried over to Form 1040, Line 2a, titled “Tax-exempt interest.” This line captures all tax-exempt interest income you received during the year.

Reporting this income on Form 1040, Line 2a, does not make it federally taxable. This line serves as an informational reporting requirement for the IRS. While the income is federal tax-exempt, some states may tax interest income from municipal bonds, especially if the bond was issued by a state other than your state of residence. Taxpayers should consult their specific state’s tax laws to determine if any state tax obligations apply to their tax-exempt OID.