Magazine article The CPA Journal

Straight-Line Deduction for OID Not Allowed

Magazine article The CPA Journal

Straight-Line Deduction for OID Not Allowed

Article excerpt

In a recent case (Peerless Industries Inc., DC EPa, No. 92-2163, 1/1/9/94), the court ruled against a taxpayer who took a straight-line interest deduction for original interest discount on a bond issued to a tax-exempt private school. In following the lead of J.C. Penney, the taxpayer attempted to get the benefit of large interest deductions on a payment that wouldn't be made for fifty years.

The corporate taxpayer was controlled by an individual who was a trustee of a small private college. He caused the taxpayer to issue a zero-coupon original issue-discount bond for $20 million payable in 50 years to the college. The present value of the bond was $23,066, which the institution paid to the taxpayer from funds the controlling stockholder personally arranged. Under the IRC and regulations in effect at the time, the taxpayer took a deduction for one-fiftieth of the original interest discount of $19,976,934 or $399,538 for each of three years. Had the taxpayer simply accrued the amount due on the amount advanced, the deduction would have amounted to approximately $3,500 for each of the years. The IRS disallowed the deductions and assessed interest and penalties.

The court noted two undisputed facts in the case. The ability at the time to write off the original issue discount on a straight-line basis motivated the taxpayer to enter into the transaction. …

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