Taxes From A To Z (2015): O Is For OID

It’s my annual “Taxes from A to Z” series! Next up:

O is for OID

OID stands for Original Issue Discount. You’ll likely hear this concept discussed in the context of bonds, and you might even have received a Form 1099-OID. There are many sophisticated OID concepts, but we’re going to focus on the most common OID issues as they relate to qualifying bonds and the issuance of Form 1099-OID. Zero-coupon bonds, which pay interest only when the bond matures, are common examples of OID bonds. Not all bonds (or debt instruments) are OID!

When you buy a bond, you’re essentially buying the right to be paid a certain amount in the future – you’re advancing money to a party in exchange for that promise. The bond issuer is agreeing to pay you the face value (or redemption price) of the bond over the life of the bond.

Depending on the kind of bond, you might pay face value for the bond, but more often than not, you pay less than face value. What you pay for the bond is called an issue price. The amount you are paid when you “turn in” or redeem the bond is called the redemption value. The difference between the two is the OID: the excess of the redemption price over the issue price. The amount of the difference is treated, in most cases, as interest.

Here’s a quick example. Let’s say I bought a $50,000 OID bond for $45,000, and I redeemed it for $50,000. The difference of $5,000 is OID and, in most cases, taxable income.

With that in mind, when you receive a Form 1099-OID for tax purposes, it should only report taxable OID. Any tax-exempt interest that is OID is not reportable on Form 1099-OID.

And it gets more complicated: the amount reported on Form 1099-OID may not be the correct amount to include in income. If it’s not (for example, maybe you bought it at a price other than the original issue price), you’ll have to make an adjustment. Additionally, the IRS has a number of situations in which you’ll figure out the taxable portion using fairly complicated formulas that involve (gasp) algebra.

Since some Forms 1099-OID can be complicated, check with your tax professional if you’re not sure how to proceed.