This section contains publicly offered, long-term debt instruments. Section I–A lists corporate debt instruments issued before 1985. Section I–B lists debt instruments issued after 1984. Section I–C lists inflation-indexed debt instruments issued after January 5, 1997.

This section contains stripped obligations available through the Department of the Treasury's Separate Trading of Registered Interest and Principal of Securities (STRIPS) program and government-sponsored enterprises such as the Resolution Funding Corporation. This section also includes instruments backed by U.S. Treasury securities that represent ownership interests in those securities.

The obligations listed in Section II are arranged by maturity date. The amounts listed are the total OID for calendar year 2002 per $1,000 of redemption price.

This section contains short-term discount obligations. Section III–A lists Treasury bills (T-bills), which are short-term discount obligations issued by the U.S. Treasury Department. Sections III–B through III–G contain short-term discount obligations issued by the Student Loan Marketing Association, Federal Home Loan Banks, the Federal National Mortgage Association, Federal Farm Credit Banks, the Federal Home Loan Mortgage Corporation, and the Federal Agricultural Mortgage Corporation.

Information that supplements Section III–A is available on the Internet at www.publicdebt.treas.gov.

The short-term obligations listed in this section are arranged by maturity date. For each obligation, the list contains the CUSIP number, maturity date, issue date, issue price (expressed as a percent of principal), and discount to be reported as interest for calendar year 2002 per $1,000 of redemption price. Brokers and other middlemen should rely on the issue price information in Section III only if they are unable to determine the price actually paid by the owner.

You can issue Form 1099–OID electronically with the consent of the recipient.

For more information, including penalties for failure to file (or furnish) required information returns or statements, see the 2002 General Instructions for Form 1099, 1098, 5498, and W–2G.

On Form 1099–OID for 2002, show the following information.

You can determine the OID on a long-term debt instrument by using either of the following.

If the owner held the debt instrument for the entire calendar year, report the OID shown in Section I for the calendar year. Because OID is listed for each $1,000 of stated redemption price at maturity, you must adjust the listed amount to reflect the instrument's actual stated redemption price at maturity. For example, if the instrument's stated redemption price at maturity is $500, report one-half the listed OID.

If the owner held the debt instrument for less than the entire calendar year, figure the OID to report as follows.

Report the result in box 1 of Form 1099–OID.

Instead of using Section I to figure OID, you can use the regulations under sections 1272 through 1275 of the Internal Revenue Code. For example, under the regulations, you can use monthly accrual periods in figuring OID for a debt instrument issued after April 3, 1994, that provides for monthly payments. (If you use Section I–B, the OID is figured using 6-month accrual periods.)

For a general explanation of the rules for figuring OID under the regulations, see Figuring OID on Long-Term Debt Instruments under Information for Owners of OID Debt Instruments, later.

Backup withholding applies to OID on a short-term obligation only when the OID is paid at maturity. However, backup withholding applies to any interest payable before maturity when the interest is paid or credited.

If the owner of a short-term obligation at maturity is not the original owner and can establish the purchase price of the obligation, the amount subject to backup withholding must be determined by treating the purchase price as the issue price. However, you can choose to disregard that price if it would require significant manual intervention in the computer or recordkeeping system used for the obligation. If the purchase price of a listed obligation is not established or is disregarded, you must use the issue price shown in Section III.

If no cash payments are made on a long-term obligation before maturity, backup withholding applies only at maturity. The amount subject to backup withholding is the OID includible in the owner's gross income for the calendar year when the obligation matures. The amount to be withheld is limited to the cash paid.

If a registered long-term obligation has cash payments before maturity, backup withholding applies when a cash payment is made. The amount subject to backup withholding is the total of the qualified stated interest (defined earlier under Definitions) and OID includible in the owner's gross income for the calendar year when the payment is made. If more than one cash payment is made during the year, the OID subject to withholding for the year must be allocated among the expected cash payments in the ratio that each bears to the total of the expected cash payments. For any payment, the required withholding is limited to the cash paid.

If the payee is not the original owner of the obligation, the OID subject to backup withholding is the OID includible in the gross income of all owners during the calendar year (without regard to any amount paid by the new owner at the time of transfer). The amount subject to backup withholding at maturity of a listed obligation must be determined using the issue price shown in Section I.

If a bearer long-term obligation has cash payments before maturity, backup withholding applies when the cash payments are made. For payments before maturity, the amount subject to withholding is the qualified stated interest (defined earlier under Definitions) includible in the owner's gross income for the calendar year. For a payment at maturity, the amount subject to withholding is only the total of any qualified stated interest paid at maturity and the OID includible in the owner's gross income for the calendar year when the obligation matures. The required withholding at maturity is limited to the cash paid.

If you report the gross proceeds from a sale, exchange, or redemption of a debt instrument on Form 1099–B for 2002, you may be required to withhold 30% of the amount reported. Backup withholding applies in the following situations.

The requirements for backup withholding and information reporting apply to payments of OID and interest made outside the United States to a U.S. person, a controlled foreign corporation, or a foreign person at least 50% of whose income for the preceding 3-year period is effectively connected with the conduct of a U.S. trade or business.

The following discussions explain the rules for backup withholding and information reporting on payments to foreign persons.

Backup withholding and information reporting are not required for payments of U.S.-source OID, interest, or proceeds from a sale or redemption of an OID instrument if the payee has given you proof (generally the appropriate Form W–8 or an acceptable substitute) that the payee is a foreign person. A U.S. resident is not a foreign person. For proof of the payee's foreign status, you can rely on the appropriate Form W–8 or on documentary evidence for payments made outside the United States to an offshore account or, in case of broker proceeds, a sale effected outside the United States. Receipt of the appropriate Form W–8 does not relieve you from information reporting and backup withholding if you actually know the payee is a U.S. person.

For information about the 30% withholding tax that may apply to payments of U.S.-source OID or interest to foreign persons, see Publication 515.

Backup withholding and information reporting are not required for payments of foreign-source OID and interest made outside the United States. However, if the payments are made inside the United States, the requirements for backup withholding and information reporting will apply unless the payee has given you the appropriate Form W–8 or acceptable substitute as proof that the payee is a foreign person.

See section 1.6049–5 of the regulations for more information about backup withholding and information reporting on foreign-source amounts or payments to foreign persons.

Generally, you report OID as it accrues each year, whether or not you receive any payments from the bond issuer.

The rules for reporting OID on long-term instruments do not apply to the following debt instruments.

See chapter 1 of Publication 550 for information about the rules for these and other types of discounted instruments, such as short-term and market discount obligations. Publication 550 also discusses rules for holders of REMIC interests and CDOs.

You can treat OID as zero if the total OID on a debt instrument is less than one-fourth of 1% (.0025) of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity. Long-term instruments with de minimis OID are not listed in this publication.

Generally, you can choose to treat all interest on a debt instrument acquired after April 3, 1994, as OID and include it in gross income by using the constant yield method. See Figuring OID using the constant yield method under Debt Instruments Issued After 1984, later, for more information.

For this choice, interest includes stated interest, acquisition discount, OID, de minimis OID, market discount, de minimis market discount, and unstated interest, as adjusted by any amortizable bond premium or acquisition premium. See section 1.1272–3 of the regulations for more information.

A debt instrument you purchased after the date of original issue may have premium, acquisition premium, or market discount. If so, the OID reported to you on Form 1099–OID may have to be adjusted. For more information, see Showing an OID adjustment under How To Report OID, later.

If your debt instrument (other than a contingent payment debt instrument or an inflation-indexed debt instrument) has premium, do not report any OID as ordinary income. Your adjustment is the total OID shown on your Form 1099–OID.

If your debt instrument has acquisition premium, reduce the OID you report. Your adjustment is the difference between the OID shown on your Form 1099–OID and the reduced OID amount figured using the rules explained later under Figuring OID on Long-Term Debt Instruments.

If your debt instrument has market discount that you choose to include in income currently, increase the OID you report. Your adjustment is the accrued market discount for the year.

Generally, you treat your gain or loss from the sale, exchange, or redemption of a discounted bond or other debt instrument as a capital gain or loss if you held the bond as a capital asset. If you sold the bond through a broker, you should receive Form 1099–B or an equivalent statement from the broker. Use the Form 1099–B or other statement and your brokerage statements to complete Schedule D (Form 1040).

Your gain or loss is the difference between the amount you realized on the sale, exchange, or redemption and your basis in the debt instrument. Your basis, generally, is your cost increased by the OID you have included in income each year you held it. To determine your gain or loss on a tax-exempt bond, figure your basis in the bond by adding to your cost the OID you would have included in income if the bond had been taxable.

See chapter 4 of Publication 550 for more information about the tax treatment of the sale or redemption of discounted debt instruments.

If you held an OID instrument for 2002 but did not receive a Form 1099–OID, refer to the later discussions under Figuring OID on Long-Term Debt Instruments for information on the OID you must report.

You must refigure the OID shown in box 1 or box 6 of Form 1099–OID to determine the proper amount to include in income if one of the following applies.

See the discussions under Figuring OID on Long-Term Debt Instruments or Figuring OID on Stripped Bonds and Coupons, later, for the specific computations

If you disposed of a debt instrument or acquired it from another holder between interest dates, see the discussion under Bonds Sold Between Interest Dates in chapter 1 of Publication 550 for information about refiguring the interest shown in box 2 of Form 1099–OID.

If you are the holder of an OID instrument and you receive a Form 1099–OID that shows your taxpayer identification number and includes amounts belonging to another person, you are considered a “nominee.” You must file another Form 1099–OID for each actual owner, showing the OID for the owner. Show the owner of the instrument as the “recipient” and you as the “payer.”

Complete Form 1099–OID and Form 1096 and file the forms with the Internal Revenue Service Center for your area. You must also give a copy of the Form 1099–OID to the actual owner. However, you are not required to file a nominee return to show amounts belonging to your spouse. See the Form 1099 instructions for more information.

When preparing your tax return, follow the instructions under Showing an OID adjustment in the next discussion.

You must use Form 1040 or Form 1040A (you cannot use Form 1040EZ) under either of the following conditions.

You must use Form 1040 (you cannot use Form 1040A or Form 1040EZ) if you are reporting more or less OID than the amount shown on Form 1099–OID, other than because you are a nominee. For example, if you paid a premium or an acquisition premium when you purchased the debt instrument, you must use Form 1040 because you will report less OID than shown on Form 1099–OID. Also, you must use Form 1040 if you were charged an early withdrawal penalty.

List each payer's name (if a brokerage firm gave you a Form 1099, list the brokerage firm as the payer) and the amount received from each payer on line 1 of Schedule 1 (Form 1040A) or line 1 of Schedule B (Form 1040). Include all OID and periodic interest shown in boxes 1, 2, and 6 of any Form 1099–OID you received for the tax year. Also include any other OID and interest income for which you did not receive a Form 1099.

If you use Form 1040 to report more or less OID than shown on Form 1099–OID, list the full OID on line 1, Part I of Schedule B and follow the instructions under (1) or (2), next.

If you use Form 1040A to report the OID shown on a Form 1099–OID you received as a nominee for the actual owner, list the full OID on line 1, Part I of Schedule 1 and follow the instructions under (1).

The rules for figuring OID on zero coupon instruments backed by U.S. Treasury securities are discussed under Figuring OID on Stripped Bonds and Coupons, later.

You should receive a Form 1099–OID showing OID for the part of the year you held the bond. However, if you paid an acquisition premium, you may need to refigure the OID to report on your tax return. See Reduction for acquisition premium, later.

If you held an OID instrument in 2002 but did not receive a Form 1099–OID, refer to Section I–A later in this publication. The OID listed is for each $1,000 of redemption price. You must adjust the listed amount if your debt instrument has a different principal amount. For example, if you have an instrument with a $500 principal amount, use one-half the listed amount to figure your OID.

If you held the instrument the entire year, use the OID shown in Section I–A for calendar year 2002. (If your instrument is not listed in Section I–A, consult the issuer for information about the issue price and the OID that accrued for 2002.) If you did not hold the instrument the entire year, figure your OID using the following method.

If you bought the debt instrument at an acquisition premium, figure the OID to include in income as follows.

If you buy or sell a debt instrument on any day other than the same day of the month as the date of original issue, the ratable monthly portion of OID for the month of sale is divided between the seller and the buyer according to the number of days each held the instrument. Your holding period for this purpose begins the day you acquire the instrument and ends the day before you dispose of it.

You figure the OID to include in your 2002 income as follows.

You increase your basis in the bonds by the OID you include in income. Your basis in the bonds when you sold them is $9,660.03 ($9,643.38 cost + $9.92 OID for 2001 and $6.73 OID for 2002).

You should receive a Form 1099–OID showing OID for the part of the year you held the bond. However, if you paid an acquisition premium, you may need to refigure the OID to report on your tax return. See Figuring OID using the constant yield method and the discussions on acquisition premium that follow, later.

If you held an OID instrument in 2002 but did not receive a Form 1099–OID, refer to Section I–A later in this publication. The OID listed is for each $1,000 of redemption price. You must adjust the listed amount if your debt instrument has a different principal amount. For example, if you have an instrument with a $500 principal amount, use one-half the listed amount to figure your OID.

If you held the debt instrument the entire year, use the OID shown in Section I–A for calendar year 2002. (If your instrument is not listed in Section I–A, consult the issuer for information about the issue price, the yield to maturity, and the OID that accrued for 2002.) If you did not hold the debt instrument the entire year, figure your OID using either of the following methods.

This computation is an approximation and may result in a slightly higher OID than Method 2.

This discussion shows how to figure OID on debt instruments issued after July 1, 1982, and before 1985, using a constant yield method. OID is allocated over the life of the instrument through adjustments to the issue price for each accrual period.

Figure the OID allocable to any accrual period as follows.

An accrual period for any OID instrument issued after July 1, 1982, and before 1985 is each 1-year period beginning on the date of the issue of the obligation and each anniversary thereafter, or the shorter period to maturity for the last accrual period. Your tax year will usually include parts of two accrual periods.

The OID for any accrual period is allocated equally to each day in the accrual period. You must include in income the sum of the OID amounts for each day you hold the instrument during the year. If your tax year includes parts of two or more accrual periods, you must include the proper daily OID amounts for each accrual period.

The daily OID for the initial accrual period is figured using the following formula.

The daily OID for subsequent accrual periods is figured the same way except the adjusted issue price at the beginning of each period is used in the formula instead of the issue price.

If you bought the debt instrument at an acquisition premium before July 19, 1984, figure the OID includible in income by reducing the daily OID by the daily acquisition premium. Figure the daily acquisition premium by dividing the total acquisition premium by the number of days in the period beginning on your purchase date and ending on the day before the date of maturity.

Assuming you still owned the bond in 2002, you would have reduced the total OID for each year (as determined in Example 10) by the allocable portion of the acquisition premium for that year. You would have included the following amounts of OID in income.

If you held the bond all of 2002, reduce the total OID for that year, $1,303.52 (as determined in Example 10), by the allocable part of the acquisition premium for 2002, $99.79 ($.27341 × 365 days). The difference, $1,203.73, is the total OID to include in income for 2002.

If you bought the debt instrument at an acquisition premium after July 18, 1984, figure the OID includible in income by reducing the daily OID by the daily acquisition premium. However, the method of figuring the daily acquisition premium is different from the method described in the preceding discussion. To figure the daily acquisition premium under this method, multiply the daily OID by the following fraction.

If you bought your corporate debt instrument in 2002 or 2003 and it is listed in Section I–A, you can figure the accumulated OID to the date of purchase by adding the following amounts.

You should receive a Form 1099–OID showing OID for the part of 2002 you held the bond. However, if you paid an acquisition premium, you may need to refigure the OID to report on your tax return. See Figuring OID using the constant yield method and Reduction for acquisition premium, later.

You may also need to refigure the OID for a contingent payment or inflation-indexed debt instrument on which the amount reported on Form 1099–OID is inaccurate. See Contingent Payment Debt Instruments or Inflation-Indexed Debt Instruments, later.

If you held an OID instrument in 2002 but did not receive a Form 1099–OID, refer to Section I–B later in this publication. The OID listed is for each $1,000 of redemption price. You must adjust the listed amount if your debt instrument has a different principal amount. For example, if you have an instrument with a $500 principal amount, use one-half the listed amount to figure your OID.

Use the OID shown in Section I–B for the calendar year if you held the instrument the entire year. (If your instrument is not listed in Section I–B, consult the issuer for information about the issue price, the yield to maturity, and the OID that accrued for 2002.) If you did not hold the debt instrument the entire year, figure your OID as follows.

If you own a tax-exempt bond, figure your basis in the bond by adding to your cost the OID you would have included in income if the bond had been taxable. You need to make this adjustment to determine if you have a gain or loss on a later disposition of the bond. Use the rules that follow to determine your OID.

This discussion shows how to figure OID on debt instruments issued after 1984 using a constant yield method. (The special rules that apply to contingent payment debt instruments and inflation-indexed debt instruments are explained later.) OID is allocated over the life of the instrument through adjustments to the issue price for each accrual period.

Figure the OID allocable to any accrual period as follows.

For debt instruments issued after 1984 and before April 4, 1994, an accrual period is each 6-month period that ends on the day that corresponds to the stated maturity date of the debt instrument or the date 6 months before that date. For example, a debt instrument maturing on March 31 has accrual periods that end on September 30 and March 31 of each calendar year. Any short period is included as the first accrual period.

For debt instruments issued after April 3, 1994, accrual periods may be of any length and may vary in length over the term of the instrument, as long as each accrual period is no longer than 1 year and all payments are made on the first or last day of an accrual period. However, the OID listed for these debt instruments in Section I–B has been figured using 6-month accrual periods.

The OID for any accrual period is allocated equally to each day in the accrual period. Figure the amount to include in income by adding the OID for each day you hold the debt instrument during the year. Since your tax year will usually include parts of two or more accrual periods, you must include the proper daily OID for each accrual period. If your debt instrument has 6-month accrual periods, your tax year will usually include one full 6-month accrual period and parts of two other 6-month periods.

The daily OID for the initial accrual period is figured using the following formula.

You may have to make adjustments if a debt instrument has a short first accrual period. For example, a debt instrument with 6-month accrual periods that is issued on February 15 and matures on October 31 has a short first accrual period that ends April 30. (The remaining accrual periods begin on May 1 or November 1.) For this short period, figure the daily OID as described earlier, but adjust the yield for the length of the short accrual period. You may use any reasonable compounding method in determining OID for a short period. Examples of reasonable compounding methods include continuous compounding and monthly compounding (that is, simple interest within a month). Consult your tax advisor for more information about making this computation.

The OID for the final accrual period is the difference between the amount payable at maturity (other than a payment of qualified stated interest) and the adjusted issue price at the beginning of the final accrual period.

If you bought the debt instrument at an acquisition premium, figure the OID includible in income by reducing the daily OID by the daily acquisition premium. To figure the daily acquisition premium, multiply the daily OID by the following fraction.

Under this method, the issuer must construct a hypothetical noncontingent bond that has terms and conditions similar to the contingent payment debt instrument. The issuer constructs the payment schedule of the hypothetical noncontingent bond by projecting a fixed amount for each contingent payment. Holders and issuers accrue OID on this hypothetical noncontingent bond using the constant yield method that applies to fixed payment debt instruments. When a contingent payment differs from the projected fixed amount, the holders and issuers make adjustments to their OID accruals. If the actual contingent payment is larger than expected, both the issuer and the holder increase their OID accruals. If the actual contingent payment is smaller than expected, holders and issuers generally decrease their OID accruals.

The amount shown in box 1 of the Form 1099–OID you receive for a contingent payment debt instrument may not be the correct amount to include in income. For example, the amount may not be correct if the contingent payment was different from the projected amount. If the amount in box 1 is not correct, you must figure the OID to report on your return under the following rules. For information on showing an OID adjustment on your tax return, see How To Report OID, earlier.

To figure OID on a contingent payment debt instrument, you need to know the “comparable yield” and “projected payment schedule” of the debt instrument. The issuer must make these available to you.

The comparable yield is the yield on the hypothetical noncontingent bond that the issuer determines and constructs at the time of issuance.

The projected payment schedule is the payment schedule of the hypothetical noncontingent bond. The schedule includes all fixed payments due under the contingent payment debt instrument and a projected fixed amount for each contingent payment. The projected payment schedule is created by the issuer. It is used to determine the holder's interest accruals and adjustments.

Figure the OID on a contingent payment debt instrument in two steps.

A net positive adjustment exists when the total of any positive adjustments described in (2) above is more than the total of any negative adjustments. Treat a net positive adjustment as additional OID for the tax year.

A net negative adjustment exists when the total of any negative adjustments described in (2) above is more than the total of any positive adjustments. Use a net negative adjustment to offset OID on the debt instrument for the tax year. If the net negative adjustment is more than the OID on the debt instrument for the tax year, you can claim the difference as an ordinary loss. However, the amount you can claim as an ordinary loss is limited to the OID on the debt instrument you included in income in prior tax years. You must carry forward any net negative adjustment that is more than the total OID for the tax year and prior tax years and treat it as a negative adjustment in the next tax year.

In general, increase your basis in a contingent payment debt instrument by the OID included in income. Your basis, however, is not affected by any negative or positive adjustments. Decrease your basis by any noncontingent payment received and the projected contingent payment scheduled to be received.

If you sell a contingent payment debt instrument at a gain, your gain is ordinary income (interest income), even if you hold the instrument as a capital asset. If you sell a contingent payment debt instrument at a loss, your loss is an ordinary loss to the extent of your prior OID accruals on the instrument. If the instrument is a capital asset, treat any loss that is more than your prior OID accruals as a capital loss.

The rules for accruing premium, acquisition premium, and market discount do not apply to a contingent payment debt instrument. See section 1.1275–4 of the regulations to determine how to account for these items.

For any date, the inflation-adjusted principal amount of an inflation-indexed debt instrument is the instrument's outstanding principal amount multiplied by the index ratio for that date. (For TIIS, multiply the par value by the index ratio for that date.) For this purpose, determine the outstanding principal amount as if there were no inflation or deflation over the term of the instrument.

This is a fraction, the numerator of which is the value of the reference index for the date and the denominator of which is the value of the reference index for the instrument's issue date.

A qualified reference index measures inflation and deflation over the term of a debt instrument. Its value is reset each month to a current value of a single qualified inflation index (for example, the nonseasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U), published by the Bureau of Labor Statistics of the Department of Labor). The value of the index for any date between reset dates is determined through straight-line interpolation.

The amount shown in box 6 of the Form 1099–OID you receive for an inflation-indexed debt instrument may not be the correct amount to include in income. For example, the amount may not be correct if you bought the debt instrument (other than at original issue) or sold it during the year. If the amount shown in box 6 is not correct, you must figure the OID to report on your return under the following rules. For information about showing an OID adjustment on your tax return, see How To Report OID, earlier.

Figure the OID on an inflation-indexed debt instrument using one of the following methods.

Under the coupon bond method, figure the OID you must report for the tax year as follows.

If you held the debt instrument at the end of the tax year, figure your OID for the year using the following steps.

Interest is reported separately, as discussed later under Stated interest.

If you sold the debt instrument during the tax year, or if it was retired, figure your OID for the year using the following steps.

Interest is reported separately, as discussed later under Stated interest.

Under the coupon bond method, you report any stated interest on the debt instrument under your regular method of accounting. For example, if you use the cash method, you generally include in income for the tax year any interest payments received on the instrument during the year.

If your calculation to figure OID on an inflation-indexed debt instrument produces a negative number, you do not have any OID. Instead, you have a deflation adjustment. A deflation adjustment generally is used to offset interest income from the debt instrument for the tax year. Show this offset as an adjustment on your Schedule B (Form 1040), in the same way you would show an OID adjustment. See How To Report OID, earlier.

In general, any premium on an inflation-indexed debt instrument is determined as of the date you acquire the instrument by assuming there will be no further inflation or deflation over the remaining term of the instrument. You allocate any premium over the remaining term of the instrument by making the same assumption. In general, the premium allocable to a tax year offsets the interest otherwise includible in income for the year. If the premium allocable to the year is more than that interest, the difference generally offsets the OID on the instrument for the year.

If you strip coupons from a bond and sell the bond or coupons, include in income the interest that accrued while you held the bond before the date of sale to the extent the interest was not previously included in your income. For an obligation acquired after October 22, 1986, you must also include the market discount that accrued before the date of sale of the stripped bond (or coupon) to the extent the discount was not previously included in your income.

Add the interest and market discount you include in income to the basis of the bond and coupons. This adjusted basis is then allocated between the items you keep and the items you sell, based on the fair market value of the items. The difference between the sale price of the bond (or coupon) and the allocated basis of the bond (or coupon) is the gain or loss from the sale.

Treat any item you keep as an OID bond originally issued and purchased by you on the sale date of the other items. If you keep the bond, treat the excess of the redemption price of the bond over the basis of the bond as OID. If you keep the coupons, treat the excess of the amount payable on the coupons over the basis of the coupons as OID.

If you purchase a stripped bond or coupon, treat it as if it were originally issued on the date of purchase. If you purchase the stripped bond, treat as OID any excess of the stated redemption price at maturity over your purchase price. If you purchase the stripped coupon, treat as OID any excess of the amount payable on the due date of the coupon over your purchase price.

None of the OID on bonds or coupons acquired before this date is taxable. The accrued OID is added to the basis of the bond or coupon. The accrued OID is the amount that produces a yield to maturity (YTM), based on your purchase date and purchase price, equal to the lower of the following rates.

Increase your basis in the stripped tax-exempt bond or coupon by the interest that accrued but was neither paid nor previously reflected in your basis before the date you sold the bond or coupon.

Part of the OID on bonds or coupons acquired after this date may be taxable. Figure the taxable part in three steps.

First figure the OID following the rules in this section as if all the OID were taxable. (See Bonds and Coupons Purchased After 1984, later.) Use the yield to maturity (YTM) based on the date you obtained the stripped bond or coupon.

Find the issue price that would produce a YTM as of the purchase date equal to the lower of the following rates.

Subtract this issue price from the stated redemption price of the bond at maturity (or, in the case of a coupon, the amount payable on the due date of the coupon). The result is the part of the OID treated as OID on a stripped tax-exempt bond or coupon.

The taxable part of OID is the OID determined in Step 1 minus the nontaxable part determined in Step 2.

None of the OID on your stripped tax-exempt bond or coupon is taxable if you bought it from a person who held it for sale on June 10, 1987, in the ordinary course of that person's trade or business.

Increase the basis of your stripped tax-exempt bond or coupon by the taxable and nontaxable accrued OID. If you own a tax-exempt bond from which one or more coupons have been stripped, increase your basis in it by the sum of the interest accrued but not paid before you dispose of it (and not previously reflected in basis) and any accrued market discount to the extent not previously included in your income.

The adjusted acquisition price of a stripped bond or coupon at the beginning of the first accrual period is its purchase (or acquisition) price. The adjusted acquisition price at the beginning of any subsequent accrual period is the sum of the acquisition price and all of the OID includible in income before that accrual period.

An accrual period for any stripped bond or coupon acquired before 1985 is each 1-year period beginning on the date of the purchase of the obligation and each anniversary thereafter, or the shorter period to maturity for the last accrual period.

In general, the YTM of a stripped bond or coupon is the discount rate that, when used in figuring the present value of all principal and interest payments, produces an amount equal to the acquisition price of the bond or coupon.

If you purchased a stripped bond or coupon after July 1, 1982, but before 1985, and the period from your purchase date to the day the instrument matures can be divided exactly into full 1-year periods without including a shorter period, then the YTM can be figured by applying the following formula.

If the instrument is a stripped coupon, the stated redemption price is the amount payable on the due date of the coupon. See Example 21.

If the period between your purchase date and the maturity date (or due date) of the instrument does not divide into an exact number of full 1-year periods, so that a period shorter than 1 year must be included, consult your broker or your tax advisor for information about figuring the YTM.

Example 21.

On November 15, 1984, you bought a coupon stripped from a U.S. Treasury bond through the Department of the Treasury's STRIPS program for $20,000. An amount of $100,000 is payable on the coupon's due date, November 14, 2009. There are exactly 25 1-year periods between the purchase date, November 15, 1984, and the coupon's due date, November 14, 2009. Your YTM on this stripped coupon is figured as follows.

Use 6.649% YTM to figure the OID for each accrual period or partial accrual period for which you must report OID.

The OID for any accrual period is allocated equally to each day in the accrual period. You figure the amount to include in income by adding the daily OID amounts for each day you hold the debt instrument during the year. If your tax year includes parts of more than one accrual period (which will be the case unless the accrual period coincides with your tax year), you must include the proper daily OID amounts for each of the two accrual periods.

The daily OID for the initial accrual period is figured by applying the following formula.

The daily OID for subsequent accrual periods is figured in the same way except the adjusted acquisition price at the beginning of each period is used in the formula instead of the acquisition price.

The rules for figuring OID on these instruments are similar to those illustrated in Example 9 and Example 10, earlier, under Debt Instruments Issued After July 1, 1982, and Before 1985.

The adjusted acquisition price of a stripped bond or coupon at the beginning of the first accrual period is its purchase (or acquisition) price. The adjusted acquisition price at the beginning of any subsequent accrual period is the sum of the acquisition price and all of the OID includible in income before that accrual period.

For a stripped bond or coupon acquired after 1984 and before April 4, 1994, an accrual period is each 6-month period that ends on the day that corresponds to the stated maturity date of the stripped bond (or payment date of a stripped coupon) or the date 6 months before that date. For example, a stripped bond that has a maturity date (or a stripped coupon that has a payment date) of March 31 has accrual periods that end on September 30 and March 31 of each calendar year. Any short period is included as the first accrual period.

For a stripped bond or coupon acquired after April 3, 1994, accrual periods may be of any length and may vary in length over the term of the instrument, as long as each accrual period is no longer than 1 year and all payments are made on the first or last day of an accrual period.

In general, the YTM of a stripped bond or coupon is the discount rate that, when used in figuring the present value of all principal and interest payments, produces an amount equal to the acquisition price.

How you figure the YTM for a stripped bond or coupon purchased after 1984 depends on whether you have equal accrual periods or a short initial accrual period.

If the period from the date you purchased a stripped bond or coupon to the maturity date can be divided evenly into full accrual periods without including a shorter period, you can figure the YTM by using the following formula.

If the instrument is a stripped coupon, the stated redemption price is the amount payable on the due date of the coupon.

Example 22.

On May 15, 1991, you bought a coupon stripped from a U.S. Treasury bond through the Department of the Treasury's STRIPS program for $38,000. An amount of $100,000 is payable on the coupon's due date, November 14, 2003. There are exactly 25 6-month periods between the purchase date, May 15, 1991, and the coupon's due date, November 14, 2003. The YTM on this stripped coupon is figured as follows.

Use 7.892% YTM to figure the OID for each accrual period or partial accrual period for which you must report OID.

If the period from the date you purchased a stripped bond or coupon to the date of its maturity cannot be divided evenly into full accrual periods, so that a shorter period must be included, you can figure the YTM by using the following formula (the exact method).

Example 23.

On May 31, 2002, you bought a coupon stripped from a U.S. Treasury bond through the Department of the Treasury's STRIPS program for $60,000. $100,000 is payable on the coupon's due date, August 12, 2008. You decide to figure OID using 6-month accrual periods. There are 12 full 6-month accrual periods and a 74-day short initial accrual period from the purchase date to the coupon's due date. The YTM on this stripped coupon is figured as follows.

Use 8.406% YTM to figure the OID for each accrual period or partial accrual period for which you must report OID.

The OID for any accrual period is allocated equally to each day in the accrual period. You must include in income the sum of the daily OID amounts for each day you hold the debt instrument during the year. Since your tax year will usually include parts of two or more accrual periods, you must include the proper daily OID amounts for each accrual period.

For the initial accrual period of a stripped bond or coupon acquired after 1984, figure the daily OID using Formula 1, next, if there are equal accrual periods. Use Formula 2 if there is a short initial accrual period.

For subsequent accrual periods, figure the daily OID using Formula 1 (whether or not there was a short initial accrual period), but use the adjusted acquisition price in the formula instead of the acquisition price.

The rules for figuring OID on these instruments are similar to those illustrated in Example 15 and Example 16, earlier, under Debt Instruments Issued After 1984.

The OID for the final accrual period for a stripped bond or coupon is the amount payable at maturity of the stripped bond (or interest payable on the stripped coupon) minus the adjusted acquisition price at the beginning of the final accrual period. The daily OID for the final accrual period is figured by dividing the OID for the period by the number of days in the period.

If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.