The nonqualified interest that you are describing is additional income
to the taxpayer, which is based upon a proportion of the discounted value of the original debt instrument, and which accrues during each tax
year. It is "phantom" interest which is taxable to the recipient, even though the taxpayer never receivedsthat portion of the interest payment. The reason why it's taxable is because the interest is considered to have been "concealed" in the original transaction
, when the debt instrument was discounted. Thus the term "Original Issue Discount," or OID. "Qualified Interest," by contrast, is the interest payable on the debt which is fixed and determinable based upon the stated rate
on the debt instrument, its face value, and number of payments. This is typically the "coupon rate" of a bond or note. Bot***** *****ne, the taxpayer in your scenario has received phantom taxable interest income. If this wasn't the original deal between the taxpayer and the bank, then maybe there's a fight brewing. Regardless, the IRS
wants its due. I hope I've answered your question. Please let me know if you require further clarification. And, please provide a positive feedback rating for my answer -- otherwise, I receive nothing for my efforts in your behalf. Thanks again for using justanswer.com!