IRC 1273: Issue Price, Redemption Price, and De Minimis OID

Original Issue Discount is determined by a single subtraction: the stated redemption price at maturity minus the issue price. Whatever remains is OID, and the tax code treats it as interest income that accrues over the life of the debt instrument rather than as a discount on the purchase price. IRC 1273 supplies the two numbers that go into that subtraction and sets a floor below which the difference is ignored.¹

The concept exists to stop investors from converting what is economically interest into capital gain. A zero-coupon bond sold for $900 and redeemed for $1,000 at maturity pays its holder $100 of interest, dressed up as a price discount. OID pulls that $100 back into ordinary income and spreads it across the years the bond is outstanding.

Finding the Issue Price

The issue price is the harder of the two numbers, because it depends on how the debt was placed and what the issuer received in exchange. IRC 1273 lays out three rules.

Publicly Offered Debt Not Issued for Property

For a public offering where the issuer receives cash, the issue price is the initial offering price at which a substantial amount of the instruments actually sold to the public. Bond houses and brokers do not count as the public for this test, so the price must reflect what real investors paid.¹

Private Placements for Cash

When the debt is not publicly offered and not exchanged for property, the issue price is the price the first buyer paid for that particular instrument.¹ Private notes and similar instruments fall here, where no broad market sets a benchmark.

Debt Issued for Property

When a debt instrument is exchanged for property, and either the debt or the property is traded on an established securities market, the issue price is the fair market value of whichever side is publicly traded.¹ If neither side trades publicly, the calculation shifts out of 1273 and into IRC 1274, which imputes an issue price by discounting the future payments at the Applicable Federal Rate. The IRS publishes the AFR monthly, and the rate that applies depends on the term of the debt.²

Finding the Stated Redemption Price at Maturity

The stated redemption price at maturity, or SRPM, is the total of all amounts the instrument promises to pay, minus any qualified stated interest. The last modification of the purchase agreement fixes this figure, so renegotiated terms control.¹

Qualified stated interest is interest paid at a fixed rate, unconditionally, at intervals of one year or less, across the full term of the bond. A bond that pays 5% semiannually has qualified stated interest, and those coupon payments are stripped out of the SRPM. The reason is straightforward. Qualified stated interest is already taxed as ordinary income as it is paid, so leaving it inside the SRPM would tax it a second time as OID. The SRPM is meant to capture only the deferred piece of the return, the part built into the discount.

The De Minimis Floor

Not every gap between issue price and SRPM produces reportable OID. If the difference is less than one-quarter of one percent (0.25%) of the SRPM multiplied by the number of complete years from issuance to maturity, OID is treated as zero.¹

A worked example makes the threshold concrete. Take a 10-year bond with an SRPM of $1,000. The de minimis amount is $1,000 × 0.0025 × 10, or $25. If the bond was issued at $980, the $20 discount sits below $25 and is disregarded for OID purposes. Issued at $970, the $30 discount clears the threshold and the full amount becomes OID subject to accrual. When a bond falls inside the de minimis range, any gain realized at maturity is treated as capital gain rather than ordinary interest.³

Debt That Has OID but Does Not Accrue Annually

Determining that a debt instrument has OID and requiring the holder to include OID in income each year are two separate questions. IRC 1272 excuses several categories from the annual inclusion rules even when the 1273 math produces a positive number.

Short-term obligations that mature within one year of issuance are outside the annual OID regime, though separate short-term discount rules can apply.
U.S. savings bonds are not subject to annual OID inclusion. Holders report the income when the bond is redeemed or reaches final maturity.
Tax-exempt obligations, including municipal bonds, are excluded from annual OID inclusion, though the OID calculation still affects a holder’s adjusted basis.
Loans between individuals are exempt when the total balance outstanding between the two people stays at $10,000 or less, the loan is not made in the lender’s trade or business, and tax avoidance is not a principal purpose. Spouses are treated as one person for the $10,000 test.

⁴

From the Determined Amount to Annual Income

Once IRC 1273 has fixed the total OID on a debt instrument, IRC 1272 governs how much of that amount enters income each year. The mechanism is the constant yield method. For each accrual period, the holder multiplies the adjusted issue price at the start of the period by the bond’s yield to maturity, then subtracts any qualified stated interest actually paid during that period. The result is the OID for the period, and it is allocated ratably across the days in the period.⁴

The adjusted issue price grows each period as accrued OID is added to it, so the daily amounts get slightly larger over time. That pattern tracks the economics of compound interest and back-loads more of the income into the later years of the bond. Each year’s OID is ordinary interest income, and the payer reports it on Form 1099-OID when the includable amount is at least $10.⁵

Every dollar of OID included in income also increases the holder’s basis in the instrument by the same dollar.⁴ That basis increase is what keeps the same discount from being taxed twice: first as OID accruing each year, and then again when the bond is sold or redeemed for its face amount. By the time the bond matures, an original $100 discount that has been fully accrued into income has also lifted the holder’s basis by $100, so redemption at face produces no additional gain.

Instruments Outside This Framework

Two situations that look like OID follow different rules and are worth flagging. A bond bought on the secondary market below its adjusted issue price generates market discount, which is governed by IRC 1276 and is generally recognized when the bond is sold or redeemed rather than annually.⁶ A bond whose interest coupons have been separated from its principal is treated under IRC 1286, which recasts each stripped piece as its own newly issued OID instrument on the date of the strip.⁷ Neither regime changes how OID is determined on an ordinary bond under 1273, but both can look similar from the outside.

1
Office of the Law Revision Counsel. 26 USC 1273 – Determination of Amount of Original Issue Discount
2
Office of the Law Revision Counsel. 26 USC 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property
3
Internal Revenue Service. Publication 1212 – Guide to Original Issue Discount (OID) Instruments
4
Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount
5
Internal Revenue Service. About Form 1099-OID – Original Issue Discount
6
Office of the Law Revision Counsel. 26 US Code 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income
7
Office of the Law Revision Counsel. 26 USC 1286 – Tax Treatment of Stripped Bonds