OID accruals on securities with doubtful collectibility.

• Author: MacNeil, C. Ellen
• Position: Original issue discount

Letter Ruling (TAM) 9538007 held that taxpayers must continue to accrue original issue discount (OID) on debt instruments even when the issuer's financial condition is such that there is no reasonable expectation that the accrued OID win be collected. The IRS National Office concluded that the doubtful-collectibility exception to the accrual of interest by accrual-method taxpayers does not extend to accruals of OID. This holding relies on the view that the OID provisions are designed to "match" the holders OID income with the issuers OID deduction and that permitting the holder to suspend accruals of OID would result in the very mismatching that the OID provisions were enacted to avoid. Case law and legislative history suggest a well-reasoned argument can be put forth that suspension of OID accruals is appropriate given serious doubtful collectibility of the OID amounts.

OID and Interest

The Supreme Court stated in Midland-Ross Corp., 381 US 54 (1965), that "[e]arned original issue discount serves the same function as stated interest....it is simply `compensation for the use or forbearance of money.'" The Court has also recognized the economic function of debt discount as interest incurred in borrowing money, see National Alfalfa Dehydrating & Milling Co., 417 US 134 (1974). Further, Congress, in enacting Sec. 1232 (the predecessor to the current OID provisions), referred to OID as "a form of interest income" (S. Rep. No. 83-1622, 83d Cong., 2d Sess. 112 (1954)). Accordingly, OID may be viewed as the equivalent of "interest," although the means by which the amount of OID accrual is determined and the general timing rules for both cash and accrual-method taxpayers are governed by Secs. 1271-1275.

In enacting the OID rules, Congress assumed that most issuers of discount bonds were deducting a portion of the discount annually, while the holders, many of whom were cash-method individuals, were including the discount in income only on disposition of the bond, if at all. If the discount was taxable only at the time of disposition, the holder was more likely to ignore that the discount was taxable and that it was ordinary income rather than capital gain. Congress believed that by requiring the bondholders to report discount income on an accrual basis, better compliance would be achieved (H. Rep. No. 91-413 (Part I), 91st Cong., 1st Sess. 109, (1969); S. Rep. No. 91-552, 91st Cong., 1st Sess. 146-147). The OID provisions are designed to parallel...