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Original issue discount – computation and reporting.

(Federal Taxation)

by Alderman, Michael

Abstract- Brokers and other middlemen are required to calculate and report the actual amount of original issue discount (OID) included in a record holder's gross income starting 1992 and onwards. Under IRC Section 6049, brokers and other middlemen need to file annual information returns with the IRS and furnish the debt instrument holder with a copy. The amount of OID currently required for reporting by the broker is the amount to be included in the original-issue debt instrument purchaser's income. Situations where a re-computation of OID for debt instruments will be required are discussed.

A long-term debt instrument generally has OID when it is issued for a price less than face value. The OID is measured by the difference between the instrument's stated redemption price at maturity and its issue price. In general, holders of these instruments must include OID in gross income over the term of the issue, regardless of accounting method. This is true even though OID will not be paid until maturity.

Issuers of publicly offered OID instruments must report OID to the IRS for inclusion in Publication 1212. Publication 1212, revised each October, serves two purposes: 1) it assists brokers and other middlemen in identifying publicly issued OID instruments so they may comply with OID reporting requirements, and 2) it helps OID debt instrument holders calculate the correct amount of OID to report on their tax returns.

IRC Sec. 6049 requires brokers and other middlemen to file annual information returns (Form 1099-OID) with the IRS and to forward a copy to the instrument holder of record. Presently, the amount of OID required to be reported by the broker is that amount includible in the income of the investor who purchased the debt instrument at original issue. For tax years prior to 1992, brokers are required to issue Form 1099-OID to each person who is a holder of record on the semi-annual interest payment record date. This reporting requirement may result in situations where the amount reported by the broker to the IRS on Form 1099-OID may not be the proper amount for the current debt instrument holder to include in his gross income. The broker's instructions to the taxpayer are not always clear or accurate, and it behooves the tax return preparer to determine the proper amount of OID Re-computation of OID would be required in the following cases:

1. The debt instrument was acquired by the taxpayer at original issue but was not held for the entire tax period;

2. The debt instrument was acquired by the taxpayer subsequent to the original issue; or

3. The debt instrument is a stripped bond or a stripped coupon.

In any of the above situations, the taxpayer must re-compute the reportable OID and should consult Publication 1212 for detailed rules and examples. The timing and the nature of income recognition and the method of OID computation vary depending upon which of the following categories the debt instrument falls:

1. Debt instruments issued after 1954 and before May 28, 1969 (or before July 2, 1982, if a government instrument). In general, OID reporting is deferred until the debt instrument is disposed of. If the debt instrument is a capital asset, gain is ordinary to the extent of accrued OID amortization. Where there is a loss on disposition, the entire loss is a capital loss.

2. Corporate debt instruments issued after May 27, 1969 and before July 2, 1982. For capital assets, a portion of the OID must be included in income for each year, or part of the year the instrument is held. If the instrument is held for part of the year, gross income must include the ratable monthly portion of OID multiplied by the number of complete months or fractions thereof that the instrument was held.

3. Debt instruments issued after July 1, 1982 and before January 1, 1985. For capital assets, a portion of the OID must be included in income for each year, or part of the year the instrument is held. However, for these instruments, the includible OID must be computed using a constant-interest method which more clearly reflects the economic accrual of interest. A "simple computation" is allowed as an alternative, but its use generally results in higher OID.

4. Debt instruments issued after December 31, 1984. The rules are generally the same for debt instruments issued after July 1, 1982, and before January 1, 1985, and apply to all instruments whether or not held as a capital asset. When the OID re-computation results in an amount that differs from the amount shown on Form 1099-OID, the amount on Form 1099- OID should be reported on Form 1040, Schedule B, Line 1. The difference between the 1099-OID amount and the recomputed amount should be shown below Line 1 and identified as an "OID adjustment." Taxpayers who in prior years incorrectly included the entire Form 1099-OID amount in taxable income, should consider filing refund claims for any open years.

Most importantly, any OID included in taxable income in any tax year should be added to the taxpayer's basis for purposes of determining gain or loss on any future disposition.

Recently finalized regulations under Sec. 6049 require brokers and other middlemen to calculate and report the actual amounts of OID includible in the gross income of each record holder for 1992 and thereafter. This change should reduce the number of taxpayers who will have to re-compute their correct OID inclusion.