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Revenue Administrative Bulletin 1988-45

Approved: September 26, 1988



RAB-88-45. This Bulletin describes Michigan income tax treatment of Original Issue Discount (OID) derived from a non-Michigan municipal bond.

Federal Income Tax Treatment

OID Defined

In general, a holder of a bond, debenture, note, or certificate or other evidence of indebtedness having an original issue discount (OID) and issued after July 1, 1982 is subject to the provisions of Section 1272 of the Internal Revenue Code (IRC). Original issue discount is defined in IRC Section 1273 as ". . . the excess (if any) of the stated redemption price at maturity, over the issue price." If the OID is less than 1/4 of 1 percent of the stated redemption price at maturity, multiplied by the number of complete years to maturity, the OID is treated as zero.

Inclusion of OID in Gross Income

Internal Revenue Code, Section 1272, requires the inclusion in gross income an amount equal to the sum of the daily portions of the OID for each day during the taxable year that the obligation is held. This income will be characterized as interest income. [Reg. 1.1272-1(a)]

Gross income will not, however, include any portion of an OID derived from a tax-exempt obligation. [See IRC Section 1272(a)(2)(A).] A tax-exempt obligation is any obligation where the interest is not includible in gross income under Section 103 of the IRC, or by any other provision of law. The obligations described in Section 103 include state and local bonds.

Determination of Amount of OID Includible in Gross Income

A holder of a debt instrument will include in gross income an amount equal to the sum of the daily portions of the OID for each day during the taxable year that the holder holds the debt instrument. See IRC Section 1272(a)(1). The daily portion of an OID is determined by allocating to each day in an accrual period its share of the increase in the adjusted issue price of the debt instrument for that period. [See IRC Section 1272(a)(3).]

Gain or Loss on Sale of Tax-exempt Obligations

Although the OID on a tax-exempt obligation is exempt from tax, the OID must be accrued to determine the holder's basis in the obligation if the tax-exempt obligation is sold prior to maturity. The gain or loss is includible in Federal gross income. [See IRC Section 1288(a).]

Michigan Income Tax Treatment

Non-Michigan Municipal Bond Interest Includible in Income

Michigan's Income Tax Act, MCL 206.30(l)(a), requires in the computation of Michigan taxable income:

...gross interest income and dividends derived from obligations or securities of states other than Michigan, in the same amount which has been excluded from Federal adjusted gross income less related expenses not deducted in computing Federal adjusted gross income because of Section 265(l) of the internal revenue code.

Pursuant to MCL 206.113, interest and dividends are allocable to this state if the taxpayer is a resident partnership, estate, trust or individual of this State or has a commercial domicile in this State.

Although the OID of a tax-exempt obligation is expressly excluded from gross income by Section 1272(a)(2)(A) of the IRC, the calculation of the OID is made for purposes of determining the holder's adjusted basis in the obligation as provided for in Section 1288 of the IRC.

To the extent that the calculation of the OID is allocated to obligations or securities of states other than Michigan, a resident taxpayer will include in Michigan taxable income the amount of the OID that ratably accrues during the taxable year on the obligation in addition to any interest paid on the obligation during the taxable year.


A Michigan individual taxpayer acquired a 20-year, 8 percent Ohio municipal bond with a principal amount of $1,000 for a price of $800 on the issue date of January 2, 1983. The $200 discount ($1,000 less $800) is the original issue discount. The $10 ratable discount ($200 divided by 20 years) is the amount of the OID that is included in Michigan taxable income per year. This amount is in addition to the inclusion of interest income earned and paid on the bond during the taxable year.