7935 / What is an exempt-interest dividend? How is a RIC shareholder taxed upon distribution of an exempt-interest dividend?

A RIC is entitled to distribute exempt-interest dividends if at least 50 percent of the value of the RIC’s total assets is invested in tax-exempt obligations at the close of each quarter of the tax year.¹

An exempt-interest dividend is any dividend that is not a capital gain dividend that is designated by the RIC as an exempt-interest dividend in statements furnished to the RIC shareholders. However, if the exempt-interest dividends reported by the RIC for the taxable year exceed the exempt interest of the RIC for that year, the exempt-interest dividend is the excess of (1) the reported exempt-interest dividend amount over (2) the excess reported amount that is allocable to the reported exempt-interest dividend amount.² Generally, the exempt-interest dividend will equal the RIC’s tax-exempt interest income minus the expenses that are allocable to that income.³

A RIC shareholder is able to exclude the amount of an exempt-interest dividend from income—the exempt-interest dividend is treated as though it were an item of interest that is excludable from gross income in the same manner as interest on state or local bonds.⁴