Regulated Investment Companies

<div class="Section1">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.<div class="Section1"><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><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;851(d)(1).<br /> <br /> </div></div><br />

<div class="Section1">If a corporation otherwise satisfies all requirements for RIC qualification, it will not be disqualified solely for failure to satisfy the 90 percent gross income test (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7923">7923</a>) if (1) the corporation files a schedule of its gross income with the IRS after identifying the failure, and the schedule contains a description of each item of its gross income and (2) the failure to satisfy the 90 percent requirement was due to reasonable cause, rather than willful neglect.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> While the corporation can avoid disqualification as a RIC by filing with the IRS as discussed above, a penalty tax will apply.&nbsp;The tax is equal to the excess of (1) the gross income of the RIC that is not derived from qualified sources (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7923">7923</a>) over (2) 1/9 of the gross income of the RIC that <em>is</em> derived from qualified sources.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;851(i)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;851(i)(2).<br /> <br /> </div></div><br />

<div class="Section1">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.</div><br /> <div class="Section1"><br /> <br /> The loss that is carried forward will be treated as a short-term capital loss if the RIC’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><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 1212(a)(3)(A).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 1212(a)(4).<br /> <br /> </div>

<div class="Section1">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 (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7928">7928</a>).<div class="Section1"><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 /> <em><em>See</em> </em> 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><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;855(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;855(b).<br /> <br /> </div></div><br />

<div class="Section1">To qualify as a RIC, a corporation must satisfy certain requirements regarding the sources of its income. At least 90 percent of the corporation&rsquo;s gross income must be derived from the following sources:<br /> <blockquote>(a)&nbsp; dividends, interest, payments with respect to securities loans and gain from the sale or other disposition of stock or securities (or foreign currencies), or other income (such as gain from options, futures or forwards contracts) derived with respect to its business of investing in such stock, securities or currencies, or<br /> <br /> (b)&nbsp; net income derived from an interest in a qualified publicly traded partnership.<a href="#_ftn1" name="_ftnref1">¹</a></blockquote><br /> Gross income of the RIC includes gain from the sale or disposition of stock or securities, but losses from such a sale or disposition are not taken into account (i.e., losses are not used to offset gain in determining whether the 90 percent requirement is satisfied).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> For a discussion of the consequences of failing to satisfy the 90 percent gross income test, <em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7924">7924</a>.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;851(b)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; Treas. Reg. &sect;&nbsp;1.851-2(b).<br /> <br /> </div></div><br />

<div class="Section1">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.&nbsp;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><div class="Section1"><br /> <br /> The special rule for calculating current earnings and profits applies even if the RIC otherwise fails the RIC qualification tests (<em><em>see</em> </em> 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).&nbsp;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><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;852(c)(1)(B).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&sect;&nbsp;852(c)(1)(B), 171(a)(2), 265.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&nbsp;852(c)(4).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; IRC &sect;&nbsp;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’s gross income to the extent of the RIC’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’s basis.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.852-4(a), IRC § 854(b).<br /> <br /> </div>

<div class="Section1">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.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><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’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—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><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 852(b)(5).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 852(b)(5)(A).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 852(b)(5)(A)(iv).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  IRC §§ 852(b)(5)(B), 103(a).<br /> <br /> </div>

<div class="Section1">A regulated investment company (RIC) is a type of domestic corporation that makes an election to be treated as a RIC and satisfies certain requirements as to income and assets. A RIC must be a corporation that has either (a) registered under the Investment Company Act of 1940 or (b) elected to be treated as a business development company.<a href="#_ftn1" name="_ftnref1">¹</a> A RIC may also be a common trust fund (or similar fund) that is not included in the definition of common trust fund under IRC Section&nbsp;584(a).<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> To be taxed as a RIC, the RIC must affirmatively make an election with its tax return by computing taxable income as a RIC.<a href="#_ftn3" name="_ftnref3">³</a>&nbsp;To qualify to make this election, the corporation must have been taxed as a RIC for all tax years ending on or after November&nbsp;8, 1983, or it must have no earnings and profits from any year in which it was not taxed as a RIC.<a href="#_ftn4" name="_ftnref4">⁴</a> Practically, this means that most corporations seeking to qualify for RIC status will need to make distributions out of accumulated earnings and profits in order to comply.<a href="#_ftn5" name="_ftnref5">⁵</a> Once a corporation elects RIC treatment, the election is irrevocable for the initial and succeeding tax years.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> Further, to qualify as a RIC, the corporation must satisfy a gross income test (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7923">7923</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7924">7924</a>) and certain asset diversification tests ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7926">7926</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7927">7927</a>). A RIC must also comply with income distribution requirements (<em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7928">7928</a>) in order to maintain its qualification.<br /> <br /> For information on the tax treatment of a qualified RIC, <em><em>see</em> </em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7929">7929</a>. For a discussion of how RIC shareholders are taxed upon the distribution of dividends, <em><em>see</em> </em> 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>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;851(a)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;851(a)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&nbsp;851(b)(1),&nbsp;Treas. Reg. &sect;&nbsp;1.851-2(a).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; IRC &sect;&nbsp;852(a)(2).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; IRC &sect;&nbsp;852(c)(3).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; Treas. Reg. &sect;&nbsp;1.851-2(a).<br /> <br /> </div></div><br />

<div class="Section1">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></div><br /> <div class="Section1"><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><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC §§ 852(a)(1)(A), 103(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 852(a)(1)(B).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 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, 1969-2 CB 147.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 852(b)(7).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.  Treas. Reg. § 1.852-1(b).<br /> <br /> </div>