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Original issue discount (OID) is a form of interest. It usually occurs when companies issue bonds at a price less than their redemption value at maturity. The difference between these two amounts is the OID.
For bonds issued after 1984, the OID is treated as interest. It's taxable as it accrues over the term of the bond. You also get to increase your basis in the bond by the amount of OID included in income. This reduces your capital gain -- or increases your loss -- when you sell it.
If the bond was issued before 1985, special rules apply:
The bond issuer will send you a Form 1099-OID. This form shows the amount of OID (Box 1) to include in your income. Sometimes you might need to recalculate the OID. Ex: You bought the bond after the date it was originally issued, and you paid a premium for it.
To learn more, see Publication 1212: Guide to Original Issue Discount (OID) Instruments at www.irs.gov.