IRC 1272: Original Issue Discount Accrual, Basis, and Reporting

Under the original issue discount rules in IRC Section 1272, if you hold a debt instrument that was issued for less than it will pay at maturity, you have to include a share of that built-in discount in your income every year as interest, even in years when the bond pays you no cash. The discount accrues daily over the life of the instrument, and you report it whether you use the cash or accrual method of accounting.

What Original Issue Discount Is

Original Issue Discount, or OID, is the gap between what a debt instrument will pay at maturity (its stated redemption price) and the lower price at which it was first issued.¹ The tax code treats that gap as interest. The issuer is effectively paying you for lending money at a below-market rate, and the code spreads that payment across your holding period rather than letting it sit until the end.

A quick example. A corporation issues a bond with a $1,000 face value for $850. The $150 difference is OID. Instead of reporting $150 of income only when the bond matures, you include a slice each year using the constant yield method.

Which Debt Instruments Are Covered

The accrual rules reach most long-term debt issued below face value. Zero-coupon bonds are the clearest case: they pay no periodic interest at all, so the entire return is discount. Corporate bonds, promissory notes, and certain Treasury obligations issued below par are also covered, as are some debt instruments issued in exchange for property when the stated interest rate falls below a statutory minimum.

Exceptions

Several categories sit outside the mandatory accrual requirement:

Tax-exempt obligations. Most municipal bonds are excluded, though separate rules govern tax-exempt OID for basis purposes.²
U.S. savings bonds. Series EE and I bonds are exempt from the annual accrual requirement.²
Short-term obligations. Debt maturing within one year of issuance follows a different set of rules under Subpart B of the code.³
Small personal loans. Loans of $10,000 or less between individuals not in the lending business are excluded, unless the loan’s principal purpose is tax avoidance.²
Holders who paid a premium. If you bought the debt instrument for more than its face value, Section 1272 does not apply to you at all.⁴

The De Minimis Rule

Even when a bond technically has OID, the amount may be too small to matter. The de minimis rule treats OID as zero when the total discount is less than one-quarter of one percent of the stated redemption price at maturity, multiplied by the number of complete years until maturity.¹ For a 10-year bond with a $1,000 face value, the threshold is $25 (0.0025 × $1,000 × 10). Anything below that is ignored for annual accrual, though it may be recognized as capital gain when the bond is sold or redeemed.

How the Annual Accrual Is Calculated

The core mechanic is the constant yield method, which allocates the discount across the life of the instrument so you earn a steady rate of return each period.⁵ Two numbers drive it: the yield to maturity and the adjusted issue price.

The yield to maturity (YTM) is the single discount rate that makes the present value of every future payment equal the original issue price. Think of it as the bond’s true annual rate of return if held to maturity. The adjusted issue price (AIP) starts as the original issue price and rises each period by the OID that has accrued, so the calculation compounds.

For each accrual period, typically six months:

Multiply the AIP at the beginning of the period by the YTM, adjusted for the period length. That gives the total interest for the period under the constant yield.
Subtract any qualified stated interest (coupon payments) the bond actually pays during the period.
The remainder is the OID for that period. Add it to the AIP going into the next period.

Because each period’s AIP is higher than the last, the dollar amount of OID grows over time even though the yield stays constant. Less income lands in the early years, more in the later years.

Daily Portions

The code requires OID inclusion on a daily basis, not just by period. Once you know the OID for a given accrual period, divide it by the number of days in that period to get the daily portion.⁵ Your annual OID income is the sum of daily portions for every day you held the instrument during the tax year.⁴ This matters most when you buy or sell mid-period, since you only pick up OID for the days you actually owned the bond.

How OID Affects Your Basis

Every year you include OID in income, your basis in the debt instrument increases by the same amount.⁴ That is what prevents double taxation. You have already paid tax on the accrued discount, so your basis rises to reflect it. By the time the bond matures, your adjusted basis should equal the redemption price, and you recognize no additional gain at maturity.

If you sell before maturity, your gain or loss is the difference between the sale price and your adjusted basis (original cost plus all OID previously included in income). It is generally treated as a capital gain or loss if you held the bond as a capital asset.² Your broker reports the adjusted basis on Form 1099-B for covered securities, so you usually do not have to keep the running total yourself.

Suppose you bought a corporate bond at its original issue price of $86,235 and included $1,214 of OID in income over several years. Your adjusted basis is now $87,449. If you sell for $90,000, your capital gain is $2,551, not $3,765. Without the basis adjustment, you would pay tax on the $1,214 twice.

OID Is Not the Same as Market Discount

OID arises at issuance, when the issuer sells the bond below face value. Market discount arises later, when a subsequent buyer picks up an already-issued bond in the secondary market for less than its adjusted issue price. The tax treatment differs.

OID must be included in income annually as it accrues, whether or not you receive any cash. Market discount is generally not recognized until you sell or redeem the bond. At that point, gain up to the amount of accrued market discount is treated as ordinary income rather than capital gain.⁶ A holder can elect to accrue market discount currently using a method similar to constant yield, but it is optional. So if you bought a bond at issuance below face, you are dealing with OID and must accrue annually. If you bought the same bond years later in the secondary market below its current adjusted issue price, that additional discount is market discount with different timing.

Stripped Bonds and Contingent Payment Instruments

When someone separates a bond’s interest coupons from its principal payment, each piece is treated as a newly issued OID bond.⁷ The OID on each piece equals the difference between its share of the purchase price (allocated by fair market value) and the amount it will pay at maturity or on the coupon date. You then accrue that OID using the constant yield method. Treasury STRIPS are the familiar example. If you own one, you receive Form 1099-OID each year for the accrued discount even though you see no cash until maturity.

Bonds whose payouts depend on uncertain future events, like commodity prices or corporate earnings, use a variation called the noncontingent bond method.⁸ The issuer builds a projected payment schedule at issuance, a comparable yield is set, and you accrue interest each period based on that yield and the adjusted issue price. When actual payments diverge from projections, adjustments run through income or deductions in the year the difference becomes clear.

Reporting OID on Your Return

If the OID on a debt instrument you hold is at least $10 for the year and the instrument has a term longer than one year, the issuer or your broker must send you Form 1099-OID.⁹ Box 1 reports taxable OID on corporate and other non-Treasury obligations; Box 8 reports OID on U.S. Treasury obligations.² You report these amounts as taxable interest on your Form 1040. If your total taxable interest for the year exceeds $1,500, you must detail the sources on Schedule B.¹⁰

If you purchased a bond directly and no 1099-OID arrives, IRS Publication 1212 provides tables and instructions for calculating the accrual yourself.²

Acquisition Premium Can Reduce Reported OID

The amount on Form 1099-OID may need adjustment if you bought the bond after issuance for more than its adjusted issue price but less than its face value. The extra amount you paid above the adjusted issue price is acquisition premium, and it reduces the OID you must include in income each day.⁴ The reduction works through a fraction: the numerator is the excess of your purchase price over the adjusted issue price, and the denominator is the total remaining OID from your purchase date to maturity. Each day’s OID is multiplied by this fraction.

Your broker may report acquisition premium separately in Box 6 of Form 1099-OID, or may report a net OID amount in Box 1 that already reflects the reduction.⁹ Check the form carefully. If Box 6 shows an acquisition premium and Box 1 shows the full unreduced OID, you subtract the premium yourself before reporting.

Penalties for Missing OID Income

Because OID accrues whether or not you receive cash, it is easy to overlook, especially on zero-coupon bonds where no payment arrives to remind you. The IRS receives a copy of every Form 1099-OID, so leaving the income off your return eventually produces a notice. If the underreported amount is large enough to constitute a substantial understatement of income tax, the accuracy-related penalty is 20% of the resulting underpayment.¹¹ That penalty applies on top of the tax owed plus interest. Gross valuation misstatements can double the penalty to 40%.¹²

Match every Form 1099-OID you receive against your return before filing. If you hold OID instruments through a brokerage, the broker handles the calculation and reporting, but you are still responsible for making sure the numbers land on your Schedule B.

1
Office of the Law Revision Counsel. 26 U.S. Code 1273 – Determination of Amount of Original Issue Discount
2
Internal Revenue Service. Publication 1212 (12/2025), Guide to Original Issue Discount (OID) Instruments
3
Office of the Law Revision Counsel. 26 USC 1283 – Definitions and Special Rules
4
Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount
5
eCFR. 26 CFR 1.1272-1 – Current Inclusion of OID in Income
6
Office of the Law Revision Counsel. 26 U.S. Code 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income
7
Office of the Law Revision Counsel. 26 U.S. Code 1286 – Tax Treatment of Stripped Bonds
8
eCFR. 26 CFR 1.1275-4 – Contingent Payment Debt Instruments
9
Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
10
Internal Revenue Service. Instructions for Schedule B (Form 1040)
11
Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments
12
eCFR. 26 CFR 1.6662-2 – Accuracy-Related Penalty