7697 / What are REMIC inducement fees? How are these fees taxed?

The IRS released regulations relating to the proper timing and source of income from fees received to induce the acquisition of noneconomic residual interests in REMICS. The regulations provide that an inducement fee must be included in income over a period reasonably related to the period during which the applicable REMIC is expected to generate taxable income (or net loss) allocable to the holder of the noneconomic residual interest. Under a special rule applicable upon disposition of a residual interest, if any portion of an inducement fee received with respect to becoming the holder of a noneconomic residual interest has not been recognized in full by the holder as of the time the holder transfers (or otherwise ceases to be the holder for federal income tax purposes) that residual interest in the applicable REMIC, the holder must include the unrecognized portion of the inducement fee in income at that time.

The regulations set forth two safe harbor methods of accounting for inducement fees, and contain a rule that an inducement fee is income from sources within the United States.¹ The Service also released the procedures by which taxpayers can obtain automatic consent to change from any method of accounting for inducement fees to one of the two safe harbor methods.² The Service reached a settlement with two entities that purportedly brokered noneconomic residual interests in a manner based on what the IRS perceived to be an overly aggressive interpretation of the tax laws.³

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1. Treas. Reg. §§ 1.446-6, 1.860C-1(d), 1.863-1(e), 1.863-1(f), 69 Fed. Reg. 26040 (5-11-2004).

2. Rev. Proc. 2004-30, 2004-1 CB 950.