Regulated Investment Companies

<div class="Section1"><br /> <br /> Prior to 2010, a RIC could carry a net capital loss that was not deductible in the current tax year as a short-term capital loss for only eight years. After December 22, 2010, however, a RIC is generally permitted to carry a capital loss forward indefinitely, though special rules now apply in determining the character of the loss as long-term or short-term capital loss.<br /> <br /> The loss that is carried forward will be treated as a short-term capital loss if the RIC&rsquo;s short-term capital losses for the year exceed its long-term capital gains. If long-term capital losses exceed short-term capital gains for the year, the loss is treated as a long-term capital loss.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> A capital loss cannot be carried back to a year in which a corporation is a RIC.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 1212(a)(3)(A).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 1212(a)(4).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> If a RIC declares a dividend on or before the later of (1) the 15th day of the ninth month following the close of the tax year or (2) the due date for filing the RIC&rsquo;s tax return if the RIC has obtained an extension of time for filing the return, the RIC can elect to treat the dividend as being paid within the tax year. In other words, in these cases, the RIC can declare a dividend in a subsequent tax year that is treated as though it was declared in the preceding tax year for purposes of meeting the income distribution requirements that apply to RICs (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7928">7928</a>).<br /> <br /> In order to qualify for this option, the RIC must also distribute the dividend to shareholders in the 12-month period following the close of the tax year, and no later than the date on which the first dividend payment is made for the same type of dividend after the dividend is declared.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> The RIC shareholder is treated as though the dividend was received in the tax year in which the distribution is made.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7933">7933</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7935">7935</a> for a discussion of the different types of dividends that may be distributed by a RIC.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 855(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 855(b).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> A RIC capital gain dividend is a dividend that the RIC designates as a capital gain dividend in a written notice to its shareholders.<a href="#_ftn1" name="_ftnref1">¹</a> If the RIC designates capital gain dividends that exceed the net capital gain of the RIC for the year, the capital gain dividend is the excess of (1) the reported capital gain dividend amount over (2) the excess reported amount that is allocable to the reported capital gain dividend amount.<a href="#_ftn2" name="_ftnref2">²</a> Generally, if a RIC reports capital gain dividends that exceed its net capital gain for the year, the designation is ineffective.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> When the RIC designates the dividend as a capital gain dividend, it must also identify the tax rate that would apply to the RIC capital gain. This means that the RIC must designate the dividend as one of the following types of distribution:<br /> <p style="padding-left: 40px">(1) a long-term capital gain distribution (taxed at the 20/15/0 percent rates that generally apply to long-term capital gains, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="704">704</a>);</p><br /> <p style="padding-left: 40px">(2) an unrecaptured Section 1250 gain distribution (taxed at 25 percent, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a>);</p><br /> <p style="padding-left: 40px">(3) a 28 percent rate gain distribution (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a>); or</p><br /> <p style="padding-left: 40px">(4) a Section 1202 gain distribution (dealing with gain that represents amounts from sale or exchange of qualified small business stock held for more than five years; a portion of this stock may be excluded from income (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7522">7522</a>)).</p><br /> The RIC shareholder is taxed on the capital gain dividend according to the type of gain distribution that is identified by the RIC.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Note that a RIC shareholder is generally taxed as though a RIC capital gain dividend is long-term capital gain, regardless of whether or not the shareholder&rsquo;s holding period was more than one year.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 852(b)(3)(C).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 852(b)(3)(C)(ii).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. See, for example, Notice 2015-41, 20154 IRB 1058.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Notice 97-64, 1997-47 IRB 7; Notice 2015-41, 20154 IRB 1058.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC &sect; 852(b)(3)(B).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Unlike in the case of an ordinary corporation, the current earnings and profits of a RIC are not reduced by amounts that are not allowed as a deduction when computing taxable income. This rule, however, does not apply to a RIC&rsquo;s <em>accumulated</em> earnings and profits. <a href="#_ftn1" name="_ftnref1">¹</a> Further, the rule excludes disallowed deductions for items relating to tax-exempt interest (so that these items <em>are</em> subtracted in determining current earnings and profits).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> The special rule for calculating current earnings and profits applies even if the RIC otherwise fails the RIC qualification tests (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7923">7923</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7928">7928</a>) and is taxed as a regular corporation.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> If a RIC has a net capital loss for the tax year, that loss is not taken into account in determining the RIC&rsquo;s earnings and profits (both current and accumulated). The amount carried over (and deemed to arise on the first day of the following tax year) is, however, taken into account in determining the RIC&rsquo;s earnings and profits for that (subsequent) tax year.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 852(c)(1)(B).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect;&sect; 852(c)(1)(B), 171(a)(2), 265.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 852(c)(4).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 852(c)(1)(A).<br /> <br /> </div></div><br />

<div class="Section1">In general, ordinary income dividends that are distributed by a RIC are included in a shareholder&rsquo;s gross income to the extent of the RIC&rsquo;s earnings and profits in the year that the dividend is received. However, if the RIC has no earnings and profits, the dividend is treated as a nontaxable return of capital that reduces the shareholder&rsquo;s basis.<a href="#_ftn1" name="_ftnref1">¹</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. &sect; 1.852-4(a), IRC &sect; 854(b).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> A RIC is entitled to distribute exempt-interest dividends if at least 50 percent of the value of the RIC&rsquo;s total assets is invested in tax-exempt obligations at the close of each quarter of the tax year.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> 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.<a href="#_ftn2" name="_ftnref2">²</a> Generally, the exempt-interest dividend will equal the RIC&rsquo;s tax-exempt interest income minus the expenses that are allocable to that income.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> A RIC shareholder is able to exclude the amount of an exempt-interest dividend from income&mdash;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.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 852(b)(5).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 852(b)(5)(A).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 852(b)(5)(A)(iv).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect;&sect; 852(b)(5)(B), 103(a).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> In certain circumstances, an otherwise qualified RIC will not be disqualified as a RIC if the asset diversification tests ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7925">7925</a>) are satisfied at the end of one quarter, but at the end of the next quarter the RIC fails the tests. If the failure arises only because of fluctuations in the value of the RIC&rsquo;s securities or because of distributions to shareholders, the RIC will not lose its status.<br /> <br /> In other words, the RIC will only be disqualified if the RIC has acquired new property or securities and the failure results from this acquisition. However, if the RIC eliminates the discrepancy causing the failure within 30 days after the close of the quarter, the RIC will be treated as though it satisfied the asset diversification tests at the close of the quarter and will not be disqualified.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 851(d)(1)<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> In order to qualify for the special provisions that apply to RICs, a RIC is required to distribute at least (1) 90 percent of its investment company income (which is, essentially, its ordinary income) for the year<a href="#_ftn1" name="_ftnref1">¹</a> and (2) 90 percent of the excess of its tax-exempt interest income over certain expenses that are allocable to that income (including expenses disallowed by IRC Section 265 (on expenses and income relating to tax-exempt income)) and deductions for amortizable bond premium that are disallowed by IRC Section 171(a)(2).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Further, the RIC (1) must have been taxable as a RIC for all years ending on or after November 8, 1983, or (2) as of the close of the taxable year, the RIC may have no earnings and profits accumulated in any taxable year in which it was not taxed as a RIC.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> In order to satisfy the distribution requirements, rather than actually distributing dividends to shareholders, the RIC may elect to credit the accounts of shareholders pursuant to a reinvestment agreement, so long as the shareholders have an unqualified right to withdraw their dividends at any time.<a href="#_ftn4" name="_ftnref4">⁴</a> The RIC may also distribute the dividends to a trustee acting on behalf of the RIC shareholders in order to satisfy the income distribution requirements.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> Dividends declared and payable to shareholders in October, November or December of any calendar year are treated as though they are paid on December 31 of the calendar year, even if they are paid in January of the following year.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> The IRS has authority to waive these distribution requirements if the RIC can establish that it was unable to meet the distribution requirements because of distributions that it previously made to avoid the excise tax under Section 4982. Otherwise, if the distribution requirements are not satisfied, the RIC will be taxed as an ordinary corporation.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect;&sect; 852(a)(1)(A), 103(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 852(a)(1)(B).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 852(a)(2).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Rul. 65-89, 1965-1 CB 265.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. Rev. Rul. 69-652, 1969 CB 147.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. IRC &sect; 852(b)(7).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. Treas. Reg. &sect; 1.852-1(b).<br /> <br /> </div></div><br />

<div class="Section1">Yes. The first remedial measure is available, and the asset diversification tests for the quarter will be deemed satisfied, if:<br /> <p style="padding-left: 40px">(1) the RIC files a schedule containing a description of each asset that caused the RIC to fail the asset tests;</p><br /> <p style="padding-left: 40px">(2) the failure is due to reasonable cause and not willful neglect; and</p><br /> <p style="padding-left: 40px">(3) the RIC disposes of the assets described in the schedule (above) within six months after the last day of the quarter in which the RIC identified the failure.<a href="#_ftn1" name="_ftnref1">¹</a></p><br /> However, if this first remedial provision is relied upon, the RIC will be liable for an excise tax equal to the greater of (1) $50,000 or (2) the amount determined by multiplying the net income generated by the assets described in the schedule over a certain period by the highest corporate income tax rate.<a href="#_ftn2" name="_ftnref2">²</a> For purposes of (2), above, the period over which the relevant income is generated is a period that begins the day the assets caused the failure and ends upon the earlier of (a) the day the assets are disposed of or (b) the end of the first quarter when there is no longer a failure).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> The second remedial measure is available for a RIC that fails the asset diversification tests if the failure is considered to be &ldquo;de minimis.&rdquo; For this purpose, a de minimis failure is one that is due to the RIC&rsquo;s ownership of assets, the total value of which does not exceed the lesser of (1) 1 percent of the total value of the RIC&rsquo;s assets at the end of the quarter or (2) $10,000,000. In this case, following identification of the failure, the RIC must dispose of the assets in order to satisfy the asset diversification tests within six months after the last day of the quarter in which the failure occurred.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 851(d)(2)(A).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 851(d)(2)(C).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 851(d)(2)(C)(ii).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 851(d)(2)(B).<br /> <br /> </div></div><br />

<div class="Section1">If a RIC satisfies the source of income, asset diversification and income distribution requirements imposed by the IRC (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7923">7923</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7928">7928</a>), it is eligible for the special tax treatment applicable to RICs. Specifically, a RIC is taxed on its investment company taxable income (ICTI), which is essentially taxable income with certain adjustments, including the following:<br /> <p style="padding-left: 40px">(1) Net capital gain is excluded;</p><br /> <p style="padding-left: 40px">(2) The net operating loss deduction under Section 172 is not allowed;</p><br /> <p style="padding-left: 40px">(3) The deductions for dividends paid (typically provided for corporations) is allowed, but is computed only taking into account ordinary taxable income distributed to shareholders (i.e., without regard to capital gain dividends and exempt-interest dividends). This deduction may be disallowed if the RIC issues preferential dividends to a certain class of shareholders (except that after December 22, 2010, the preferred dividend rule no longer applies to publicly offered RICs);<a href="#_ftn1" name="_ftnref1">¹</a> and</p><br /> <p style="padding-left: 40px">(4) Any tax imposed under IRC Section 851(d)(2) and (i) are excluded (these taxes are those imposed on the RIC for failure to meet its asset diversification tests in any quarter).<a href="#_ftn2" name="_ftnref2">²</a></p><br /> The tax imposed on ICTI is the applicable Section 11 corporate tax rate. If the RIC is a personal holding company, the highest Section 11 rate applies.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> A RIC is also taxed on capital gains. The tax is imposed on the excess of the net capital gain over the deduction for dividends paid (essentially, the tax is imposed on the RIC&rsquo;s capital gains less the capital gains dividends it distributes to shareholders).<a href="#_ftn4" name="_ftnref4">⁴</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7934">7934</a> for a discussion of a RIC shareholder&rsquo;s tax treatment of a capital gain dividend.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Rul. 89-81, 19896 IRB 17; IRC &sect; 562(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 852(b).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 852(b)(1).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 852(b)(3).<br /> <br /> </div></div><br />