When you buy a bond for less than face value (a discount), part of your return is the climb toward par at maturity. Original issue discount (OID) and market discount are different rules. OID on many taxable bonds generally accrues into income each year. Market discount (buying a seasoned bond below its revised issue price) is usually not taxed annually unless you elect to include it currently; otherwise it is often recognized when you sell or redeem (IRS Pub 550). That is the mirror image of bond premium amortization.
This is a plain-English overview, not IRS Publication 550 or a CPA memo. Price sensitivity still belongs to Bond duration basics. Wrapper basics: Taxable brokerage account basics.
Premium, par, discount (tax theme map)
| Situation | Purchase vs par | Typical tax theme (taxable bond) |
|---|---|---|
| Premium | Price > face | Amortization may reduce taxable interest and basis |
| Par | Price ≈ face | Interest ≈ coupon; basis ≈ face until sale/maturity |
| Discount | Price < face | OID often accretes annually; market discount usually waits until sale/redemption unless you elect annual inclusion |
OID generally applies when the bond was issued below par and typically creates annual taxable interest and basis increases. Market discount can apply when you buy a seasoned bond below its revised issue price; annual taxation of market discount generally requires an election, otherwise recognition is often deferred to disposition. Munis and Treasuries have special flavors. Do not assume every “discount” bond follows the same OID worksheet.
What accretion does
In simplified terms, for a taxable OID bond you often accrete each year:
- Taxable interest for the year can include coupon cash plus an accreted discount amount (you may owe tax on income you did not receive as a separate “discount check”).
- Your adjusted basis rises by the accreted amount.
- At maturity, basis trends toward face, so the built-in discount is less likely to appear as one large capital gain that was really unpaid interest.
Brokers often report OID and related amounts on Form 1099-OID / 1099-INT supplements. Read the year-end package; do not re-create schedules from coupon stubs alone.
Why cash and tax can diverge
You might receive a $400 coupon while the tax worksheet adds $75 of accretion, taxable interest looks like $475 even though only $400 hit the checking account. Inside an IRA or 401(k), annual OID reporting usually does not matter the same way; you care about cash flows and risk, not 1099 accretion.
Comparing bonds on yield alone without tax timing: see Yield to maturity basics. Holding periods for any capital gain or loss on a sale still follow trade dates: Capital gains holding periods.
Worked example
Alex buys a newly issued taxable corporate bond with $10,000 face for $9,400 ($600 OID) in a Fidelity taxable account. Annual cash coupon: $350. For a given year, assume reportable OID accretion is $90 (actual constant-yield figures from the broker or IRS tables will differ).
- Cash coupon: $350
- Illustrative taxable interest: $350 + $90 = $440
- Basis after that year’s OID accretion: $9,400 + $90 = $9,490
If Alex holds to maturity and OID accretes fully, basis approaches $10,000 and the discount has been taxed over time as interest-like income. If this were instead market discount on a seasoned bond, Alex would usually not add $90 each year unless Alex elected current inclusion; without the election, much of the discount is often recognized at sale or redemption. Market yields can still move the market price day to day; duration explains those swings, not the tax worksheet.
Practical cues
- Prefer bond funds/ETFs if you do not want lot-level OID schedules (Investing basics for beginners).
- On individual bonds, download broker tax documents every January; match 1099-OID lines to lots.
- Market-discount elections (include annually vs at sale) are technical, material amounts deserve a CPA/EA.
- Tax-exempt munis can still have taxable market-discount quirks; read muni-specific instructions, not only corporate OID examples.
Checklist
- Note purchase price vs face on every individual taxable bond lot.
- Watch for 1099-OID / supplemental accretion in the broker tax package.
- Keep adjusted basis after each year’s accretion for sale or maturity math.
- Separate OID, market discount, and premium amortization. Do not mix worksheets.
- Use IRS Publication 550 when amounts are material; ask a tax professional for elections.
- Judge risk with duration and credit quality separately from the tax schedule.
Educational only. Not tax, legal, or investment advice. OID, market-discount, and broker reporting rules change; confirm with current IRS publications, Form 1099 instructions, and a qualified tax professional.