How is original issue discount profit at maturity treated for tax purposes?

How is original issue discount profit at maturity treated for tax purposes?

• A. As capital gains
• B. As ordinary income
• C. As tax-free interest
• D. As a deductible expense

Answer: (C)

The treatment of original issue discount (OID) profit at maturity for tax purposes is considered ordinary income. When a bond is issued at a discount, the amount of the discount is effectively interest income that the bondholder earns over the life of the bond. This discount reflects the difference between the bond's face value and its issue price, and it accrues over time. At maturity, the entire OID income is taxable as ordinary income, which means it is treated like interest income for tax reporting purposes. Therefore, when the bond matures and the investor receives the face value, they recognize this profit as regular income on their tax returns, not capital gains or any other category. This treatment aligns with how interest is usually treated under tax law. The choices that suggest capital gains, tax-free interest, or a deductible expense do not accurately reflect how OID is treated. Capital gains typically apply to the appreciation in the value of an asset held beyond one year, tax-free interest does not apply since OID is indeed taxable, and a deductible expense does not fit the context of OID at maturity. Thus, the correct understanding emphasizes that OID profit is accounted for as ordinary income when the bond matures.

The treatment of original issue discount (OID) profit at maturity for tax purposes is considered ordinary income. When a bond is issued at a discount, the amount of the discount is effectively interest income that the bondholder earns over the life of the bond. This discount reflects the difference between the bond's face value and its issue price, and it accrues over time.

At maturity, the entire OID income is taxable as ordinary income, which means it is treated like interest income for tax reporting purposes. Therefore, when the bond matures and the investor receives the face value, they recognize this profit as regular income on their tax returns, not capital gains or any other category. This treatment aligns with how interest is usually treated under tax law.

The choices that suggest capital gains, tax-free interest, or a deductible expense do not accurately reflect how OID is treated. Capital gains typically apply to the appreciation in the value of an asset held beyond one year, tax-free interest does not apply since OID is indeed taxable, and a deductible expense does not fit the context of OID at maturity. Thus, the correct understanding emphasizes that OID profit is accounted for as ordinary income when the bond matures.