J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

4.18 Discount on Bonds

There are two types of bond discounts: original issue discount and market discount.

Market discount.

Market discount arises when the price of a bond declines because its interest rate is less than the current interest rate. For example, a bond originally issued at its face amount of $1,000 declines in value to $900 because the interest payable on the bond is less than the current interest rate. The difference of $100 is called market discount. The tax treatment of market discount is explained in 4.20.

Original issue discount (OID).

OID arises when a bond is issued for a price less than its face or principal amount. OID is the difference between the principal amount (redemption price at maturity) and the issue price. For publicly offered obligations, the issue price is the initial offering price to the public at which a substantial amount of such obligations were sold. All obligations that pay no interest before maturity, such as zero coupon bonds, are considered to be issued at a discount. For example, a bond with a face amount of $1,000 is issued at an offering price of $900. The $100 difference is OID.

Generally, part of the OID must be reported as interest income each year you hold the bond, whether or not you receive any payment from the bond issuer. This is also true for certificates of deposit (CDs), time deposits, and similar savings arrangements with a term of more than one year, provided payment of interest is deferred until maturity. OID is reported ...