7627 / Is an investor who holds a short-term taxable corporate obligation required to include discount in income prior to sale or maturity? Is an investor required to include interest as it accrues?

Original issue discount (OID) is the difference between the issue price and the stated redemption price on a taxable corporate debt instrument having a maturity date of one year or less and is generally not included in income by a cash basis investor prior to sale or redemption.¹ Interest payable on such bonds is generally not included in income by a cash basis taxpayer until it is received. However, a cash basis investor may elect to include original issue discount as it accrues. Such an election may not be limited to a particular obligation but applies to all short-term taxable corporate obligations (and to Treasury bills with respect to acquisition discount) acquired on or after the first day of the first taxable year for which the election is made, and it continues to apply until the Service consents to revocation of the election.² If a taxpayer elects to include discount as it accrues, he or she must also include stated interest (not otherwise included in income until it is paid) as it accrues.³

The taxpayer making the election must include as income an amount equal to the sum of the daily portions of original issue discount (in the case of T-bills, daily portions of acquisition discount) for each day that the taxpayer held the obligation in the tax year.

An irrevocable election may be made, on an obligation-by-obligation basis, to determine the amount of original issue discount by using daily compounding at a constant interest rate.⁴

Rather than electing to include original issue discount as it accrues, a taxpayer may elect to include “acquisition discount” (the difference between the stated redemption price at maturity and the basis in the obligation) as it accrues.⁵ The manner in which acquisition discount accrues is discussed in Q 7625.The election to accrue acquisition discount applies to all such obligations (and Treasury bills) acquired by the taxpayer on or after the first day of the first taxable year to which the election applies and thereafter until the Service consents to a revocation.