No, not really. Those crazy 1099s you may have received refer to Original Issue Discount—and that probably gives you as much of a clue as Odd but Interesting Doohickeys.
This is another one of the pieces of paper that arrive at the tax preparer’s office with a sticky note that says, “What do I do with this?”
OID is the unstated interest earned on debt instruments and deferred payment transactions. When adequate interest is not paid on a debt instrument, interest income must be imputed to the holder of the debt. The imputed interest is reported to you on 1099-OID. I can see your eyes glazing over already.
Dr. Gene calls this phantom income—which is a good analogy—because you do not receive any interest income in the form of cash but you have to pay taxes on it.
The most common debt instrument sold that affects lots of taxpayers is a Zero Coupon Bond or STRIP from the U.S. Treasury. In the last week of March 2003 you could buy a U.S. Treasury STRIP for your 9-year-old to mature in August 2012 when college tuition is due for 58:14 yielding 5.8%. This means that you could buy a $1,000 face bond for $584.38. In August 2012 you will receive a crisp $1,000 bill and have earned 5.8% on your investment (remember—you only earn the expected yield on bonds if you hold them until maturity).
Each year the bond increases in value by the amount of imputed interest (plus or minus the market discount or premium). Glazing over again…O.K. If market interest rates did not change from one year to the next, your bond should be worth what you paid for it plus those 1099-OID amounts on which you are paying taxes. However, in the real world, interest rates change all of the time. Therefore, you cannot compute your OID amount and what to put on your tax return by subtracting the market value of the bond on December 31st in the prior year from the market value on December 31st in the current year. You need to have that 1099-OID.
OID applies to instruments due more than six months after the date of purchase. Therefore, if you buy a 90-day Treasury bill in November, you will not receive a 1099-OID for the one or two months of interest earned. OID also does not apply to U.S. Savings Bonds.
So, remember to put that 1099-OID amount on your tax return on Schedule B – Interest Income. And if it is OID from a U.S. Government STRIP, remember to subtract it from your total interest income when doing your state tax return as U.S. Government interest is exempt from state income tax. If you would like further information regarding this topic or any other tax related issue, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.