Final regs expand use of simplified money market fund calculations, make other changes
Final regs expand use of simplified money market fund calculations, make other changes
In response to changes made several years ago in Securities and Exchange Commission (SEC) rules on how certain money market fund (MMF) shares are priced, IRS has issued final regs that provide a simplified method for MMF shareholders to account for gains and losses on MMF shares. The final regs make several changes to 2014 proposed regs, including expanding the availability of the simplified method to all MMFs.
Background on money market funds. An MMF is a type of investment company registered and regulated under the Investment Company Act of 1940 (1940 Act). Unlike other types of mutual funds, MMFs have historically sought to keep stable (typically at $1.00) the prices at which their shares are issued and redeemed. The types of securities that MMFs are permitted to hold and the share-pricing and valuation methods specific to MMFs have made stable prices possible.
Generally, an MMF must hold a diversified portfolio of short-term, low-risk, liquid securities. The securities that an MMF holds generally result in no more than minimal fluctuations in the MMF’s net asset value per share (NAV). The perceived safety and simplicity of MMFs have led to their widespread use as cash management vehicles, resulting in frequent purchases and redemption of money market fund shares by investors. MMFs are often used as sweep accounts into which cash is automatically deposited on a daily basis.
The SEC has voted to require certain MMFs to price shares in a manner that more accurately reflects the market value of the funds’ underlying portfolios. These particular MMFs will no longer be able to utilize the special exemptions that currently allow them to maintain a stable net asset value (NAV), and instead the share price will float, so the funds will be known as “floating-NAV” MMFs. If a shareholder frequently purchases and redeems shares (as is the case where the fund is used as a “sweep arrangement”), the shareholder may experience a high volume of small gains and losses. Tax compliance might be difficult and burdensome if these taxpayers had to ascertain the cost basis and gain or loss for each transaction.
Proposed regs. In response to the SEC rule change, IRS issued proposed guidance (see Weekly Alert ¶ 21 07/31/2014) providing a simplified, aggregate annual method of tax accounting for gains and losses in a floating-NAV MMF. Under the proposed regs, a floating-NAV MMF is an MMF that distributes, redeems, and repurchases its shares at prices that are computed by rounding the MMF’s current net asset value per share to a minimum of the fourth decimal place in the case of an MMF with a share price at or about $1.0000 or an equivalent or more precise level of accuracy for an MMF with a different share price.
The proposed regs provided a permissible, simplified method of accounting for gain or loss on shares in a floating-NAV MMF (the net asset value method, or NAV method). Under this method, gain or loss is based on the change in the aggregate value of the shares in the floating-NAV MMF during a computation period (which may be the taxpayer’s tax year or certain shorter periods) and the net amount of the purchases and redemptions during the period. The taxpayer’s net gain or loss from shares in a floating-NAV MMF for a computation period generally equals the value of the taxpayer’s shares in the MMF at the end of the period, minus the value of the taxpayer’s shares in the MMF at the end of the prior period, minus the taxpayer’s net investment in the MMF during the period.
Thus, the proposed regs allowed shareholders to measure net gain or net loss without transaction-by-transaction calculations, simplifying tax compliance for shareholders.
Final regs expand availability of, and make changes to, NAV method. The final regs expand the availability of the NAV method to stable-NAV MMFs and make several other changes to the proposed reg rules regarding the NAV method.
… Expanded availability of the NAV method. Unlike the proposed regs, the final regs permit taxpayers to apply the NAV method to shares in stable-NAV MMFs. (Reg. § 1.446-7(a))
IRS notes that, although stable-NAV MMFs seek to maintain constant share prices, there are circumstances in which shares in a stable-NAV MMF will give rise to gain or loss. On rare occasions, shares in a stable-NAV MMF may be redeemed at a price other than the target price. In addition, a stable-NAV MMF may impose liquidity fees, which will generally result in the realization of a loss by a redeeming shareholder. (T.D. 9774)
If the acquisition of other shares causes such a redemption to be a wash sale, the wash sale rules will generally cause the basis of the acquired shares to exceed the cost of the shares. Because the price of a stable-NAV MMF share rarely changes, any disposition of those acquired, higher-basis shares will likely result in another loss, which also may be deferred by the wash sale rules. Therefore, even if a liquidity fee is in effect for only one redemption by a shareholder and the share price of the MMF remains constant, that fee may cause a difference between the basis and value of the shareholder’s MMF shares that persists indefinitely. Determining gain or loss and basis on each transaction in a stable-NAV MMF, taking into account the wash sale rules, would impose significant burdens on shareholders under these circumstances. (T.D. 9774)
The NAV method will reduce the complexity that would result from the imposition of a liquidity fee by a stable-NAV MMF. Under the NAV method, any loss that resulted from the imposition of a liquidity fee by an MMF would be determined for a shareholder’s entire interest in the MMF (or in an account) for the appropriate tax year (or computation period) rather than for a single transaction. Therefore, the wash sale rules would not defer the loss. The NAV method also requires fewer and simpler computations than traditional accounting, even if there are no wash sales. (T.D. 9774)
… Removal of consistency requirement. The proposed regs provided that if a taxpayer applies the NAV method to shares in any MMF for a tax year, the taxpayer must apply the NAV method to its shares in all MMFs for which that method is permissible.
Noting, for example, that some taxpayers may receive sufficient information about their shares in certain MMFs to compute gain or loss realized on each transaction and that those taxpayers should be permitted to compute gain or loss realized on each transaction for those MMFs (T.D. 9774), IRS amended the final regs to permit taxpayers to apply different methods to shares in different MMFs or to shares in a single MMF held in different accounts. (Reg. § 1.446-7(c)(1))
… Computation periods, generally. The proposed regs provided that computation periods may be the taxpayer’s tax year or a shorter period, provided that (i) computation periods are of approximately equal duration, (ii) every day during the tax year falls within one, and only one, computation period, and (iii) each computation period contains days from only one tax year.
The final regs eliminate the requirement that computation periods be of approximately equal duration. (Reg. § 1.446-7(b)(1)(i))
… Computation periods for RICs that hold MMF shares. Most regulated investment companies (RICs) must pay an excise tax under Code Sec. 4982 if they do not make the required distribution described in Code Sec. 4982(b) for a calendar year. The required distribution is generally 98% of the RIC’s ordinary income for the calendar year, plus 98.2% of the RIC’s capital gain net income for the 1-year period ending on October 31 of the calendar year. RICs generally account for items that are marked to market using two different 1-year periods for income tax and excise tax purposes. Under Code Sec. 4982(e)(2)(A), the term “capital gain net income” when used in Code Sec. 4982 is determined by treating the 1-year period ending on October 31 of any calendar year as the company’s tax year. Code Sec. 4982(e)(4) provides an election to use the RIC’s tax year instead for purposes of this capital gain rule.
The final regs provide that a RIC that holds MMF shares may use the NAV method for excise tax computations and that a RIC that uses the NAV method is permitted to use the relevant period under Code Sec. 4982(e), i.e., generally, the 1-year period from November 1 to October 31, as its computation period for excise tax purposes. (Reg. § 1.446-7(b)(1)(iii))
The final regs, however, require a RIC to be consistent in applying the NAV method to MMF shares for income tax and excise tax purposes. For each MMF in each account, the final regs generally require a RIC to use the NAV method either for both income tax and excise tax computations or for neither computation. (Reg. § 1.446-7(c)(6))
… Fair market value of MMF shares. Under the proposed regs, gain and loss under the NAV method would be determined by reference to the fair market value of MMF shares. The proposed regs did not define the term “fair market value of MMF shares.”
The final regs provide that the fair market value of a share in an MMF is presumed to be the applicable published redemption amount for the share. (Reg. § 1.446-7(b)(3)(i)) The published redemption amount for a share in an MMF at the time of a transaction is presumed to be the published NAV (or other published amount for which the MMF would redeem the share, determined without regard to any liquidity fees (other redemption amount)). (Reg. § 1.446-7(b)(3)(ii)) For purposes of computing the ending value for a computation period, the presumption applies to the last published NAV (or other redemption amount) in that computation period. For purposes of determining the fair market value of MMF shares surrendered or received in a redemption or exchange, the presumption generally applies to the NAV (or other redemption amount) used to determine the consideration received in the transaction, or if the consideration is not based on a published NAV (or other redemption amount), the first NAV (or other redemption amount) published for the MMF shares after the transaction. (Reg. § 1.446-7(b)(3)(iii))
If no NAV (or other redemption amount) is published, or if facts and circumstances indicate that the NAV (or other redemption amount) does not represent the fair market value of a share in the MMF, the fair market value is determined on the basis of all the facts and circumstances. (Reg. § 1.446-7(b)(3)(iv))
… Aggregate amount received. Subject to adjustments not relevant here, the net gain or loss for each computation period with respect to the shares in an MMF to which the NAV method applies equals the ending value, minus the starting basis, minus the net investment in the MMF for the computation period. (Reg. § 1.446-7(c)(2)(i))
Under the proposed regs, a taxpayer’s net investment in an MMF for a computation period may be a positive amount, a negative amount or zero. (Prop Reg § 1.446-7(b)(5)(i)) It equals the aggregate cost of shares in the MMF purchased during the computation period (Prop Reg § 1.446-7(b)(5)(i)(A)), minus the aggregate amount received during the computation period in redemption of shares in the MMF if the transaction is one in which gain or loss would be recognized (Prop Reg § 1.446-7(b)(5)(i)(B)), subject to certain adjustments. (Prop Reg § 1.446-7(b)(5)(ii))
Under the final regs, Reg. § 1.446-7(b)(5)(i)(B) refers to transactions in which gain or loss would be recognized if the taxpayer did not apply the NAV method to the shares.
The final regs also add a definition of “aggregate amount received” for this purpose. The aggregate amount received is: a) if no property other than cash and shares in one or more other MMFs is received, the amount of any cash plus the fair market value of any MMF shares received; and b) if any property other than cash or shares in one or more other MMFs is received, the fair market value of the redeemed MMF share. (Reg. § 1.446-7(b)(5)(ii))
… Acquisitions other than by purchase. Under the proposed regs, a taxpayer’s net investment would increase if, during the computation period, the taxpayer acquired any shares in an MMF other than by purchase. In such cases, the net investment increases by the adjusted basis (for purposes of determining loss) of each such share immediately after its acquisition. However, the proposed regs do not address a situation in which the shareholder receives a transferred basis in MMF shares acquired from another person.
The final regs provide that, if a shareholder receives a transferred basis in one or more acquired MMF shares and the person from whom the shareholder acquired the shares used the NAV method, then the adjusted basis of the acquired shares will be their fair market value at the time of the acquisition (Reg. § 1.446-7(b)(5)(iii)(B)), which value is presumed to be the next NAV (or other redemption amount) published by the MMF. (T.D. 9774)
Reporting by MMFs. The proposed regs also extended to floating-NAV MMFs the waiver of gross-proceeds reporting, basis reporting, and holding-period reporting rules that previously applied only to stable-value MMFs.
The final regs keep this rule. ((Reg. § 1.6045-1(c)(3)(vi)(A)))
Changing to or from the NAV method. IRS has issued, at the same time as T.D. 9774, a Revenue Procedure containing the procedures by which a taxpayer may obtain IRS’s automatic consent to change to or from the NAV method. See ¶ 2.
Effective dates. Reg. § 1.446-7 generally applies to tax years ending on or after July 8, 2016. For tax years ending on or after July 28, 2014 (the reliance date for the proposed regs) and beginning before July 8, 2016, however, shareholders of MMFs may rely either on the rules concerning the NAV method in the proposed regs or in the final regs. (Reg. § 1.446-7(e)))
The rule under “Reporting by MMFs,” above, applies to sales of shares in calendar years beginning on or after July 8, 2016. Taxpayers and brokers however, may rely on that rule for sales of shares in calendar years beginning before July 8, 2016. (Reg. § 1.6045-1(c)(3)(vi)(B))
References: For accounting for money market fund transactions, see FTC 2d/FIN ¶ G-2039; United States Tax Reporter ¶ 4464.93.