Tax treatment of bonds
§The price appreciation on original issue discount (OID) bonds is an implicit interest payment. Hence the IRS
calculates a price appreciation and imputes
taxable interest income. Additional
gains or losses due to market yield
changes are treated as capital gains.
§Example: An 8% 30 yr. bond issued at 81.071% of par is sold for 820.95 at the end of the year. If interest
income is taxed at 36% and capital gains at
28%, the tax paid equals 0.36(80 + 811.80 - 810.71) + 0.28(820.95-811.80) = $31.75.
(YTM at issue = 10%; yearend price using this YTM = 811.80)
(YTM at issue = 10%; yearend price using this YTM = 811.80)