Original Issue Discount (OID) is a form of interest income. The OID amount is the excess of a debt’s redemption price at maturity over the issue price.
A company may issue a bond at a discount because it is facing financial troubles. In order to raise the capital, they need to entice investors with a large OID amount to issue the bonds. Many bonds issued at a discount with OID will also pay a coupon to the investors. However, a zero-coupon bond is a form of bond where the only interest paid is OID.
Example OID Investment
Company ABC is having financial difficulties and needs to raise capital. They want to issue 5-year $10,000 bonds with a 6% coupon, however, no investors are taking the opportunity. The company decides to lower the issue price to $9,600 with the 6% coupon.
John decides to purchase the 5-year bond issued for $9,600 with a redemption amount of $10,000. The OID amount is $400, which is the difference between the issue price and the stated redemption amount ($10,000 minus $9,600).
The IRS requires the payor to report the OID amounts on Form 1099-OID (Original Issue Discount).
OID Included in Gross Income
U.S. taxpayers must generally include OID in their gross income each year. The amount of OID included in gross income is equal to the sum of the daily portions of such OID for each day during the tax year the investor holds the instrument.1
Additional Information
Taxpayers can find more information on interest income and OID by visiting the IRS website and reviewing IRS Publication 1212 (Guide to Original Issue Discount – OID).