Using Pub. 1212 to Report Original Issue Discount

IRS Publication 1212 provides guidance for taxpayers who need to report income from investments with Original Issue Discount (OID). OID is a type of interest that is not paid out in cash each year. Instead, it is the interest that accrues over the life of a debt instrument, such as a bond, and must be accounted for annually.

Understanding Original Issue Discount (OID)

Original Issue Discount is created when a debt instrument is issued for a price less than its stated value at maturity. This difference between the issue price and the redemption price is the OID. For example, a zero-coupon bond issued for $800 that will be worth $1,000 at maturity has $200 of OID.

The IRS requires holders of OID instruments to include a portion of the discount in their taxable income each year, even though no cash is received. This is because the investment’s value increases as it nears maturity. This annual inclusion of OID also increases the holder’s cost basis in the instrument, which reduces the capital gain or increases the capital loss when it is sold or redeemed.

Many long-term debt instruments can have OID, including:

• Bonds
• Debentures
• Notes
• Certificates of deposit (CDs) with terms exceeding one year

The OID rules generally do not apply to U.S. savings bonds, tax-exempt municipal bonds, and certain loans of $10,000 or less between individuals.

An exception that exempts many from reporting is the de minimis OID rule. If the total discount is less than 0.25% of the bond’s stated redemption price, multiplied by the number of full years to maturity, the OID is considered zero for tax purposes. For instance, a 10-year bond with a $1,000 face value must have an OID of at least $25 ($1,000 x 0.0025 x 10) to be subject to annual reporting.

Decoding Form 1099-OID

If you have OID income, the financial institution holding your investment will send you Form 1099-OID, Original Issue Discount. This form details the income you need to account for, but the figures reported may require adjustment.

Box 1 shows the “Original issue discount” that accrued during the part of the year you owned the instrument. This amount is often the starting point for your calculation. Box 2, “Other periodic interest,” shows any regular, stated interest paid on the instrument, which is also taxable. An amount in Box 3, “Early withdrawal penalty,” may be deducted from your income.

Box 6, “Acquisition premium,” is for taxpayers who purchased their bond for more than its adjusted issue price. This premium can be used to reduce the amount of OID you must report, as explained in the next section. Box 8 contains the “Original issue discount on U.S. Treasury obligations,” which is taxable on your federal return but exempt from state and local income taxes. Box 11, “Bond premium,” applies when you purchase a bond for more than its face value.

Adjustments to Your Reported OID

The OID amount in Box 1 or Box 8 of Form 1099-OID is not always the final taxable figure. The most common adjustment is a reduction for the acquisition premium paid when you bought the bond. This adjustment prevents you from being taxed on the portion of the OID that you effectively paid for at purchase.

To make the adjustment, you subtract the acquisition premium shown in Box 6 from the OID shown in Box 1. For example, if Box 1 reports $100 of OID and Box 6 reports $20 of acquisition premium, your taxable OID for the year is $80. This adjusted amount is what you will include in your taxable interest income.

Reporting OID on Your Tax Return

After determining the correct taxable OID, you must report it on Schedule B (Form 1040), Interest and Ordinary Dividends. You must file Schedule B if you are making an adjustment to the OID amount from your Form 1099-OID.

First, report the full OID amount from Box 1 or Box 8 of your Form 1099-OID on line 1 of Schedule B. List the payer’s name and the gross OID amount. This step ensures that the amount you report initially matches the information the IRS received from the payer.

Directly below this entry, list your adjustment as a separate line item. Use a description like “OID Adjustment” or “Acquisition Premium Adjustment” and enter the reduction amount as a negative number in parentheses. For example, a $20 reduction for an acquisition premium would be entered as “($20)”.

Subtract the adjustment from the gross OID to find the net taxable OID. This net figure is then included with your other interest income to calculate the total on line 2 of Schedule B. This total interest is then carried over to your Form 1040.