Original issue discount

Original issue discount

Original Issue Discount (OID) is a type of interest that is not payable as it accrues. OID is normally created when a debt, usually a bond, is issued at a discount. In effect, selling a bond at a discount converts stated principal into a return on investment, or interest. The accurate determination of principal and interest is necessary in United States tax law to determine the basis of property and to determine whether an amount paid is deductible and includible as interest, or simply a nontaxable debt repayment.

Example Original Issue Discount

Bond Issuance Price $7,462
Bond Redemption Price $10,000
Original Issue Discount $2,538

Most loans require interest payments. Loans that require inadequate or no interest payments bear original issue discount. Whether interest is adequate is determined with reference to the applicable federal rate (AFR). Under the Federal Income Tax Code, original issue discounts on debt instruments are taxed each year, even though the debt may not be repaid until a later date. The tax system will impute an interest rate on the loan. The rules for calculating the original issue discount utilize a compounding interest formula, with the principal recalculated every six months. Section 1272(a) of the tax code requires that the amount of taxable income is equal to the daily portion of the original issue discount.[1].

The daily portion of the discount uses a compounded interest formula with the principal recalculated every six months. The following table illustrates how to calculate the original issue discount for a $7,462 bond with a $10,000 repayment and a three year maturity date[2]:

Period Adjusted Issue Price Yield Original Issue Discount
1 $7,462 .05 $373
2 $7,835 .05 $392
3 $8,227 .05 $411
4 $8,638 .05 $432
5 $9,070 .05 $454
6 $9,524 .05 $476
Redemption $10,000

The portion of the loan that is repaid consists of a repayment of capital and a payment of interest. Original issue discount rules separate the portion of the repayment that is attributable to interest and then taxes that amount at ordinary income rates. These rules prevent the avoidance of tax that might otherwise be available by characterizing the repayment as a capital gain, which is taxed at a lower rate, or by deferring the recognition of income until the bond is repaid at maturity.

There are a number of exceptions to the original issue discount rule, including:

  • Tax exempt obligations
  • United States savings bonds
  • Short-term obligations (less than 1 year to maturity)
  • Obligations fixed by natural persons before 3/2/1984
  • Loans between natural persons

References

  1. ^ http://www.law.cornell.edu/uscode/26/usc_sec_26_00001272----000-.html
  2. ^ Adapted from Michael Graetz and Deborah Schenk, "Federal Income Taxation: Principles and Policies"

Wikimedia Foundation. 2010.

Игры ⚽ Нужна курсовая?

Look at other dictionaries:

  • Original Issue Discount — (OID) USA The discount from the face value of a bond or other debt instrument at the time that it is issued. It is the difference between the stated redemption price at maturity and the offering price. This discount is amortized over the life of… …   Law dictionary

  • original issue discount — (OID) USA The discount from the face value of a bond or other debt instrument at the time that it is issued. It is the difference between the stated redemption price at maturity and the offering price. This discount is amortized over the life of… …   Law dictionary

  • original issue discount — ( OID) The amount of the difference between the par or redemption price and the price of the security at the time of its original issue. Issuers can issue securities with OID as an alternative to making periodic interest payments as a means of… …   Financial and business terms

  • original-issue discount — ( OID) The amount of the difference between the par or redemption price and the price of the security at the time of its original issue. Issuers can issue securities with OID as an alternative to making periodic interest payments as a means of… …   Financial and business terms

  • Original Issue Discount - OID — The discount from par value at the time that a bond or other debt instrument is issued. It is the difference between the stated redemption price at maturity and the issue price. An original issue discount bond is a bond issued at a price below… …   Investment dictionary

  • original issue discount securities — ( OIDS) bonds on which the coupon rate is set considerably below the yield to maturity at the time of issuance so that the bonds are issued at a discount from a par value. Bloomberg Financial Dictionary …   Financial and business terms

  • Original issue discount debt (OID debt) — Debt that is initially offered at a price below par. The New York Times Financial Glossary …   Financial and business terms

  • original issue discount debt — ( OID debt) debt that is initially offered at a price below par. Bloomberg Financial Dictionary …   Financial and business terms

  • discount securities — (1) Securities that do not pay periodic interest. Investors earn the difference between the discount issue price and the full face value paid at maturity. Treasury bills, banker s acceptances, and zero coupon bonds are discount securities. Most… …   Financial and business terms

  • Discount Home Shoppers' Club — Discount Home Shoppers Club, Inc. Founded 1997 Founder(s) Richard Burke Headquarters Englewood, Florida Key people Will Burke Website www.dhs club.com …   Wikipedia

Share the article and excerpts

Direct link
Do a right-click on the link above
and select “Copy Link”