If you have ever owned a bond, chances are you have at least heard about Original Issue Discount, or OID for short. Simply put, it is the difference between the amount you paid for the bond and it's redemption value.

IRS considers OID to be a form of interest that accrues as you hold the bond. And even if you are a cash based taxpayer, as most of us are, you must pay taxes on this accrued interest every year that you hold the bond. Of course, you don't see this money until the bond matures, or you sell it. Nevertheless, the Government gets its cut of it every year.

Once you get rid of the bond, you adjust your cost basis up by the amount of OID. Your gain on the bond is then computed based on your sales or redemption price minus the adjusted basis. So, this adjustment avoids double taxation.

Pretty straight forward so far, right? Well, here is where it gets complicated. IRS has an entire 16 page Publication 1212, http://www.irs.gov/pub/irs-pdf/p1212.pdf that tells you how to properly calculate OID for all the different bonds out there. Apparently, this was too much work for some brokers, like Fidelity Investments and so they outsourced this calculation to a third party provider.

Yet, once you sell or redeem your bond, Fidelity Investments, for one, will report your adjusted cost basis for the bond, not based on the third party OID calculations they report on your 1099s, but based on their own calculations. This can result in significant discrepancies - at least it did in my case.

Fidelity Investments suggested fix? For 2013 you can just ignore their adjusted cost basis and calculate one on your own. Apparently, brokers are only required to report cost basis for bonds bought starting in 2014. In the past, bond cost basis calculations were for "informational purposes only" and never reported to the IRS.

So, what about 2014 and beyond? Fidelity Investments promises to take all future OID calculations in house. Presumably that will solve the problem!

P.S. I am not an accountant. As, always, my articles only expresses my opinions and are not to be taken as advice.

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