Zero coupon bonds are an example of an OID.
This long-term debt instrument has
Original Issue Discount (OID) when it is issued for a price less than its
stated redemption price at maturity (principal amount). The OID is the
difference between the stated redemption price at maturity and the issue
price. OID is considered to be a form of interest. All debt instruments that
pay no interest prior to maturity (zero coupon bonds) are presumed to be
issued at a discount. The majority of OID bonds are zero coupon bonds.
However, it is possible for a bond making periodic coupon payments to also
De minimis OID
The IRS allows bond issuers to disregard OID
(treat it as zero) if it is less than one-forth of 1% (.0025) of the stated
redemption price times the number of full years from the date of original
issue to maturity.
You bought a 10-year bond with a
stated redemption price at maturity of $1,000, issued at $980 with
OID of $20. One-fourth of 1% of $1,000 (stated redemption price)
times 10 (the number of full years from the date of original issue
to maturity) equals $25. Because the $20 discount is less than $25,
the OID is treated as zero. (If you hold the bond at maturity, you
will recognize $20 ($1,000 − $980) of capital gain.)
The facts are the same as in
Example 1, except that the bond was issued at $950. The OID is
$50. Because the $50 discount is more than the $25 figured in
Example 1, you must include the OID in income as it accrues over
the term of the bond.
The issuer of the debt instrument (or your
broker, if you held the instrument through a broker) should give you
Form 1099-OID, Original Issue Discount, or a similar statement, if the
total OID for the calendar year is $10 or more. Form 1099-OID will show,
in box 1, the amount of OID for the part of the year that you held the
bond. It also will show, in box 2, the stated interest that you must
include in your income. A copy of Form 1099-OID will be sent to the IRS.
In most cases, you must report the entire
amount in boxes 1 and 2 of Form 1099-OID as interest income.
Exceptions to reporting OID
The OID rules do not apply to the
following debt instruments.
- Tax-exempt obligations.
(However, see Stripped tax-exempt obligations under
Stripped Bonds and Coupons in chapter 1 of Publication 550).
- U.S. savings bonds.
- Short-term debt instruments
(those with a fixed maturity date of not more than 1 year from
the date of issue).
- Obligations issued by an
individual before March 2, 1984.
- Loans between individuals, if
all the following are true.
- The lender is not in the
business of lending money.
- The amount of the loan,
plus the amount of any outstanding prior loans between the
same individuals, is $10,000 or less.
- Avoiding any federal tax
is not one of the principal purposes of the loan.
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