If you bought a bond for less than its face value, the IRS's de minimis rule may require you to treat part of that discount as interest income you owe taxes on every year, even though you won't see a cash payment until the bond matures or you sell it. This is called original issue discount, or OID, and whether it counts as taxable interest comes down to a specific formula in IRS Publication 550. Below, we walk through the math using a 10-year bond example so you can see when a discount is too small to matter and when it isn't.
What counts as OID in the first place
Before you can figure out whether OID is taxable, you need to know what the IRS considers OID at all. Publication 1212 defines a bond's stated redemption price at maturity as the total of every principal and interest payment due on the bond, excluding qualified stated interest. Qualified stated interest is, in general, regular interest that is unconditionally payable in cash at least once a year at a single fixed rate, the sort of payment you'd get from a typical coupon bond. That stated redemption price at maturity figure, rather than the bond's face value alone, is what the de minimis test measures your discount against.
The de minimis threshold formula
The IRS lets you treat OID as zero, meaning you owe nothing on it, if the discount is smaller than a specific threshold: one-fourth of one percent (0.0025) of the stated redemption price at maturity, multiplied by the number of full years from original issue to maturity, though a modified formula applies to installment obligations with more than one stated principal payment and the rule generally does not apply to tax-exempt obligations. For a typical $1,000, 10-year bond, that works out to a threshold of $25. If your discount falls below that number, the IRS lets you treat the OID as zero, meaning you don't have to report it as interest income year by year. If it meets or exceeds that number, the entire discount becomes taxable and must be spread out over the life of the bond using the constant yield method described in Publication 1212.
Worked example: a 10-year bond bought at $950
Say you buy a 10-year corporate bond with a $1,000 face value, but instead of paying full price, you pay just $950 at original issue. First, calculate the de minimis threshold: multiply 0.0025 by the $1,000 stated redemption price, then multiply by the 10 full years to maturity, which gives you $25. Next, compare that threshold to your actual discount. Your OID here is $50, the difference between the $1,000 face value and the $950 purchase price, and IRS Publication 550's own Example 2 uses this exact scenario to illustrate the rule. Because $50 is more than the $25 threshold, the entire $50 discount fails the de minimis test and must be included in your taxable income as it accrues over the bond's term, not just when the bond matures or you sell it. Had you instead paid $980 for the same bond, your $20 discount would have fallen below the $25 threshold, and you could have treated the OID as zero.
- rate: 0.0025 - stated redemption price: 1000 - years: 10 - Formula: rate\stated redemption price\years - Result: 25
Buying a bond after it's already issued changes things
The math above assumes you bought the bond directly at original issue. If you instead buy a bond with de minimis OID on the secondary market, from another investor rather than from the issuer, different rules kick in depending on what you pay. If you buy it at a premium, meaning you pay more than the bond's adjusted basis, the IRS says that original discount is not includible in your income at all. But if you buy it at a discount, that discount is instead reported under the separate market discount rules rather than as OID. This distinction matters because market discount and OID are taxed under related but distinct sets of rules, and mixing them up can lead to reporting the wrong amount in the wrong year.
Five kinds of debt where OID rules don't apply at all
- Tax-exempt obligations are excluded from the OID accrual rules.
- U.S. savings bonds are also excluded from these OID rules.
- Short-term debt instruments with a fixed maturity of one year or less from issue fall outside the OID rules.
- Loans of $10,000 or less between individuals are excluded, as long as the loan isn't made in the course of a trade or business and avoiding tax isn't a principal purpose of the loan.
- A debt instrument purchased at a premium is excluded from the OID accrual rules.
Knowing whether a bond falls into one of these five categories tells you upfront whether you need to run the de minimis threshold formula at all.
| Scenario | Discount amount | De minimis threshold | Taxable as OID? |
|---|---|---|---|
| 10-year, $1,000 bond bought at original issue for $980 | $20 | $25 | No, below threshold, treated as zero |
| 10-year, $1,000 bond bought at original issue for $950 | $50 | $25 | Yes, full $50 must accrue as taxable interest |
| Bond with de minimis OID bought later at a premium | Varies | Not applicable to this scenario | No, not includible in income |
| Bond with de minimis OID bought later at a discount | Varies | Not applicable to this scenario | Reported under market discount rules instead of OID |
- Find the bond's stated redemption price at maturity, which is the total of all principal and interest due, excluding qualified stated interest.
- Count the number of full years from the original issue date to the maturity date.
- Multiply 0.0025 by the stated redemption price and by the number of full years to get your de minimis threshold.
- Compare your actual discount to that threshold: if it's smaller, you can treat the OID as zero; if it's equal to or larger, the full amount must accrue as taxable interest.
- Check whether your bond falls into one of the five exempt categories, such as tax-exempt obligations or debt bought at a premium, before applying any of the above.
Key takeaways
- OID is the gap between a bond's purchase price and its stated redemption price at maturity, which excludes regular qualified stated interest.
- The de minimis threshold is 0.0025 times the stated redemption price times the number of full years to maturity, which comes to $25 for a standard 10-year, $1,000 bond.
- If the discount is below that threshold, you can treat OID as zero; if it meets or exceeds it, the full discount must be reported as accruing interest income each year.
- Buying a bond with de minimis OID after original issue changes the tax treatment: a premium purchase means no tax on the discount, while a discount purchase shifts it to the market discount rules.
- Five categories of debt are exempt from these OID rules altogether: tax-exempt obligations, U.S. savings bonds, short-term debt of one year or less, small loans of $10,000 or less between individuals, and debt bought at a premium.
Frequently asked questions
Does the de minimis threshold change based on the bond's face value or term?
Yes. The formula multiplies 0.0025 by the stated redemption price at maturity and by the number of full years to maturity, so a larger face value or a longer term produces a larger dollar threshold. A $1,000, 10-year bond has a $25 threshold under that formula.
If my OID is below the de minimis threshold, do I ever have to report it?
Discount below the threshold can be treated as zero, meaning it isn't included in income as it accrues. This specific treatment applies to instruments subject to the standard de minimis test; a modified formula applies to installment obligations with more than one stated principal payment, and the rule generally does not apply to tax-exempt obligations.
What happens if I buy a bond with de minimis OID from another investor instead of at original issue?
Paying a premium means the discount isn't included in your income, while paying a discount means it gets reported under the market discount rules instead of as OID.
Is qualified stated interest the same thing as OID?
No, in general qualified stated interest is regular interest unconditionally payable in cash or property (other than debt instruments of the issuer) at least annually over the term of the debt instrument at a single fixed rate, and the IRS excludes it from the stated redemption price at maturity used to calculate OID, treating it separately from OID.
Does buying a bond at a premium ever trigger OID tax treatment?
No. A debt instrument purchased at a premium is one of the five categories listed as exempt from these OID accrual rules entirely.