What Is Original Issue Discount and How Is It Taxed?

Original issue discount, or OID, is the built-in interest represented by the gap between what you pay for a debt instrument when it is issued and the larger amount the issuer promises to pay you at maturity. If you buy a bond for $900 that redeems at $1,000, that $100 spread is OID. The IRS treats it as interest income and requires you to report a slice of it each year you hold the bond, even though the cash does not arrive until maturity or sale. That mismatch between tax and cash flow is why OID trips up so many investors.

How Federal Tax Law Defines OID

OID is the difference between two numbers: the stated redemption price at maturity and the issue price. The stated redemption price is the total the issuer promises to pay at the end, including face value and any fixed amounts due at maturity, but not periodic interest paid at a fixed rate at least once a year.¹ If the redemption price exceeds the issue price, the bond has OID.

The issue price itself depends on how the bond was sold. For a publicly offered bond sold for cash, it is the initial offering price at which a substantial amount of the bonds actually sold to investors, not the price used between broker-dealers. For a bond that was not publicly offered, the issue price is what the first buyer paid.¹ When a debt instrument is issued in exchange for property rather than cash, separate rules determine the issue price, and the IRS may impute a principal amount using a test discount rate if stated interest is inadequate.²

Which Instruments Carry OID

Zero-coupon bonds are the clearest case. They pay no periodic interest, so the entire return is the spread between the discounted purchase price and face value at maturity. The OID is large and unambiguous.

Stripped bonds start as ordinary coupon bonds, but a dealer separates the interest coupons from the principal payment and sells each piece individually at a discount. Federal law treats the stripped bond and each stripped coupon as a separate debt instrument with its own OID.³

Certificates of deposit can generate OID as well. A CD with a term longer than one year that defers interest until maturity, or that is issued at a discount, triggers OID reporting. The bank must file Form 1099-OID if the OID for the year is $10 or more.⁴ OID on short-term CDs of one year or less goes on Form 1099-INT instead.⁵

Treasury Inflation-Protected Securities create a less obvious form of OID. When inflation pushes up the principal of a TIPS bond, that increase is reported on Form 1099-OID and taxed in the year it occurs, even though you will not receive the adjusted principal until maturity.⁶ In deflationary periods, the principal can decrease, which reduces your taxable OID.

Tax-exempt municipal bonds can also be issued at a discount. The OID itself is generally tax-exempt, so you do not include it in income the way you would with a taxable bond. You still have to calculate it, though, because it increases your basis. Skipping the calculation means overstating your gain (or understating your loss) when you sell or redeem the bond.⁷

Treasury bills are sometimes grouped with OID bonds but follow a different path. T-bills mature in 52 weeks or less and are short-term obligations with their own reporting rules.⁸

How OID Accrues Each Year

The IRS does not let you split the discount into equal annual slices. OID accrues under the constant yield method, which mirrors compound interest. For each accrual period, you multiply the bond’s adjusted issue price (the original issue price plus all OID already accrued) by the yield to maturity, then subtract any interest the bond actually pays in that period. The result is that period’s OID.⁹

Because the adjusted issue price grows as OID accrues, the dollar amount included in income is smaller in early years and larger as maturity approaches. A $1,000 face-value zero-coupon bond bought for $600 with a 10-year term might generate $30 of OID in year one and $55 in year nine.

The Phantom Income Problem

Federal law requires you to include a portion of the discount in gross income every year you hold the instrument, whether or not you actually receive any cash.⁷ A zero-coupon bond paying nothing for 20 years still produces a tax bill each year. You need cash from other sources to cover it.

The offset is a basis adjustment. Each year’s OID inclusion increases your tax basis in the bond by the same amount.⁷ If you bought a bond for $600 and reported $400 of OID over its life, your adjusted basis at maturity is $1,000. When the bond redeems at $1,000, there is no additional gain. Without the basis adjustment you would pay tax on the same $400 twice, once as OID and again as capital gain.

Four categories of instruments are excluded from the annual accrual requirement: tax-exempt bonds, U.S. savings bonds, short-term obligations maturing in one year or less, and small personal loans under $10,000 between individuals when tax avoidance is not the purpose.⁹ Everything else follows the annual rules.

The De Minimis Exception

A small discount escapes OID treatment entirely. If the discount is less than one-quarter of one percent of the stated redemption price, multiplied by the number of complete years to maturity, OID is treated as zero for tax purposes.¹

For a 10-year, $1,000 face-value bond, the threshold is 0.25% × $1,000 × 10 = $25. A discount at or below that line skips the annual accrual entirely, and any gain from the discount is treated as capital gain when you sell or redeem. That distinction matters: the same income taxed at ordinary rates through annual accrual could instead qualify for the more favorable capital gains rate below the threshold.

Reporting OID on Your Tax Return

Your broker or the issuer will send you Form 1099-OID each year if the OID includible in your gross income is $10 or more.⁴ Box 1 shows the total OID for the year, and Box 8 shows OID on a tax-exempt obligation. Treasury interest goes on Form 1099-INT instead, with OID on short-term obligations of one year or less reported in Box 1 of that form.⁵

You report OID on Schedule B of Form 1040. If the amount you need to report differs from what appears on your 1099-OID, enter the full form amount and then subtract the difference with a line item labeled “OID Adjustment.”¹⁰ If your broker already netted an adjustment against the OID on the 1099-OID, you cannot take a second reduction on Schedule B.

The IRS receives the same 1099-OID that you do. Mismatches between what was reported to the IRS and what you filed get flagged automatically, and consistent underreporting can draw the 20% accuracy-related penalty on underpayments caused by negligence or substantial understatement of income.¹¹

Buying an OID Bond After Issuance

Bonds change hands in the secondary market, and the price a later buyer pays rarely matches the original issue price. Two distinct situations follow, with very different tax consequences.

Acquisition Premium

If you buy an OID bond for more than its adjusted issue price (original issue price plus OID that accrued before you bought it), the excess you paid is acquisition premium. It reduces the OID you must include in income each year. The reduction works as a fraction: divide the acquisition premium by the total OID remaining from your purchase date to maturity, then multiply the result by each period’s OID to get the reduction.⁹ Most brokers do this calculation and report the net figure on your 1099-OID.

Market Discount

If you buy an OID bond for less than its adjusted issue price, the shortfall is market discount, not additional OID, and it follows a different regime. By default, you do not include market discount in income each year. When you sell the bond or it matures, any gain up to the accrued market discount is taxed as ordinary income rather than capital gain.¹²

You can elect to include market discount in income as it accrues instead. Once made, the election applies to all market discount bonds you acquire from that point forward and cannot be revoked without IRS consent.¹³ Some investors prefer this to avoid a large ordinary income hit in the year the bond matures.

Selling Before Maturity

When you sell an OID bond before it matures, your gain or loss equals the sale price minus your adjusted basis. Adjusted basis is what you originally paid plus all OID you have included in income while holding it.⁷ For most individual investors, the bond is a capital asset, so any difference from that adjusted basis is a capital gain or loss.

Suppose you bought a zero-coupon bond for $700, held it five years, and included $150 of OID in income over that time. Your adjusted basis is $850. Sell for $860 and your capital gain is $10, not $160. You already paid ordinary-income tax on the $150. Forgetting to track those inclusions means paying tax twice on the same income. For covered securities your broker reports the adjusted basis on Form 1099-B, but verifying it yourself is worth the time.

Short-Term Obligations Follow Different Rules

Debt maturing in one year or less, such as Treasury bills and commercial paper, is excluded from the standard OID accrual rules.⁹ Whether current inclusion is required depends on the holder. Banks, regulated investment companies, accrual-method taxpayers, dealers holding obligations for sale to customers, and holders of stripped bonds must include the acquisition discount currently.¹⁴

A cash-method individual investor who holds a T-bill to maturity generally recognizes the discount when the bill matures or is sold. The discount on these instruments goes on Form 1099-INT rather than Form 1099-OID.⁵

OID Inside a Retirement Account

Holding OID bonds inside an IRA or other tax-deferred account removes the phantom income problem. Financial institutions are not required to file Form 1099-OID for assets held in an IRA, because the income is not currently taxable.⁵ OID still accrues economically, but no tax is owed until you take distributions, at which point the entire distribution is taxed as ordinary income. For investors bothered by paying tax on money they have not received, holding zero-coupon bonds inside a retirement account is the cleanest fix.

1
Office of the Law Revision Counsel. 26 USC 1273 – Determination of Amount of Original Issue Discount
2
eCFR. 26 CFR 1.1274-2 – Issue Price of Debt Instruments to Which Section 1274 Applies
3
Office of the Law Revision Counsel. 26 USC 1286 – Tax Treatment of Stripped Bonds
4
Internal Revenue Service. About Form 1099-OID, Original Issue Discount
5
Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
6
TreasuryDirect. Treasury Inflation-Protected Securities (TIPS)
7
Internal Revenue Service. Publication 1212 (12/2025), Guide to Original Issue Discount (OID) Instruments
8
TreasuryDirect. Treasury Bills
9
Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount
10
Internal Revenue Service. Instructions for Schedule B (Form 1040)
11
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
12
Office of the Law Revision Counsel. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income
13
Office of the Law Revision Counsel. 26 USC 1278 – Definitions and Special Rules
14
Office of the Law Revision Counsel. 26 USC 1281 – Current Inclusion in Income of Discount on Certain Short-Term Obligations