Original Issue Discount (OID)

Original Issue Discount (OID) is the difference between the issue price of a bond and its face value. It is the interest that accrues over the life of the bond and is not paid until the bond matures. OID is calculated using the bond's yield to maturity.

OID is important because it affects the tax treatment of a bond. For tax purposes, OID is treated as interest income, even though it is not actually paid until the bond matures. This means that investors must pay taxes on OID even though they may not have the cash to do so.

There are two ways to calculate OID: the effective interest method and the straight-line method. The effective interest method is the more accurate method, but it is also more complex. The straight-line method is simpler to calculate, but it is less accurate.

The effective interest method is used to calculate the interest that accrues on a bond each year. The interest rate used is the bond's yield to maturity. The interest is then added to the bond's cost basis, which is the amount that the investor paid for the bond.

The straight-line method is used to calculate the OID that is amortized over the life of the bond. The OID is divided by the number of years to maturity, and the resulting amount is amortized each year.

The amount of OID that is amortized each year is taxed as interest income. This means that investors must pay taxes on the OID even though they may not have the cash to do so.

OID can be a significant tax liability for investors, especially if they hold bonds with long maturities. Investors should consult with their tax advisor to determine how OID will affect their taxes.