§1281 Current Inclusion in Income of Discount on Certain Short-term Obligations

Summary

You must include in your taxable income each day the part of a short-term debt discount that applies while you own the debt, and you must also include any other interest on the debt as it accrues. This rule applies to short-term obligations held by people who use the accrual method of accounting; obligations held mainly for sale in a trade or business; banks; regulated investment companies or common trust funds; obligations identified as part of a hedging deal under section 1256(e)(2); and stripped bonds or coupons held by the person who stripped them (or by someone whose tax basis comes from that person). The rule also covers short-term obligations held by pass-through entities when those entities are used to avoid the rule or when the obligation is bought during the “required accrual period.” A pass-through entity means a partnership, S corporation, trust, or similar entity. The required accrual period starts when, for at least 90 days in a year, people covered above own 20 percent or more of the entity’s value, and it ends after the first year that test is not met with IRS consent. See section 1283(c) for special limits on original issue discount for nongovernmental obligations.