Final OID regulations provide guidance on debt instruments.

• Author: Turnage, R. Jeff
• Position: Original issue discount

The IRS has issued final regulations under Secs. 163, 446, 483 and 1271-1275 relating to the tax treatment of debt instruments with original issue discount (OID) and the imputation of interest on deferred payments under certain contracts for the sale or exchange of property. These regulations are effective for debt instruments issued after Apr. 3, 1994, and also may be relied on by taxpayers for debt instruments issued after Dec. 21, 1992. The final regulations generally adopt the methodologies established in the most recent proposed rules issued on Dec. 22, 1992.

The final regulations provide guidance to holders and issuers of OID instruments as to when (and how much) income should be reported for accretion of discount or deducted as interest or amortized premium. The regulations also provide a revised treatment for pro rata prepayments and clarify the rules on determination of yield and maturity of a debt instrument with one or more stated contingencies. In addition, the regulations confirm that interest prepaid on a loan at closing should be recognized as OID an deferred over the life of the loan.

While the OID regulations ca be complicated, taxpayers should review the rules applicable to debt instruments to benefit from planning opportunities and t avoid unexpected pitfalls.

Issuers of debt instruments

Corporations issuing debt obligations now have more definitive guidance for computing the amount of OID for purposes of Form 1099-OID reporting and for deducting interest expense o their tax returns. (Additional guidance for Form 1099-OID reporting will be issued later by the IRS.) Generally, the issue may deduct OID under its overall accounting method (cash or accrual basis) using the constant yield method described in Regs. Sec. 1.1272-1(b). De minimis OID under Regs. Sec. 1.1273-1(d) may be deducted at maturity on straight-line basis over the term of the debt instrument, or in proportion to stated interest payments (Regs. Sec. 1.163-7(b)). The issuer makes the election by deducting the OID computed under the chosen method on its timely filed tax return for the tax year in which the instrument is issued.

Issuers of debt obligations also have specific guidance with respect to partial redemptions of a debt obligation that qualify as pro rata prepayments. Under the proposed rules, all payments would have been applied first to accrued stated interest, then to accrued OID and finally to principal. The final regulations require a pro rata...