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Tax Talk with George Saenz

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Reporting original issue discount income

Dear Tax Talk:
What does "original issue discount" mean when it comes to preparing taxes? If it is reported, when and where?

Dear Spencer:
Original issue discount (OID) is kind of in the nature of interest earnings.

When a person buys a bond from the original issuer, the bond may be for a greater value than what is actually paid because of changes in interest rates. This is known as the discount from par.

For example, say AT&T issued a $100,000 bond at a fixed rate of interest of 6 percent, which means the bond will pay $6,000 in interest annually. But after AT&T set the rate on the bond, interest rates went up to 7 percent.

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For AT&T to attract investors to buy that bond, since the investor could otherwise earn $7,000 elsewhere, AT&T has to offer it at a discount from $100,000. So AT&T sells the bond at $90,000, allowing the investor to earn $10,000 in additional interest when the bond matures at $100,000. This $10,000 discount is in reality additional interest to the investor, and, therefore, the investor is required to include it in income annually as OID, rather than when actually paid at maturity.

The issuer of the bond will provide you with a Form 1099 for the amount of OID annually. For individual filers, this annual OID is reported on Form 1040, Schedule B.

-- Posted: March 6, 2002

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See Also
Schedule B: box-by-box instructions
A closer look at tax-reporting statements

Tax Basics: Investment income

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