August 2014
Practice Groups:
Investment
Management, Hedge
Funds and
Alternative
Investment
Tax
New Tax Guidance Would Simplify Rules for
Shareholders of Institutional Money Market Funds
By Roger S. Wise, Theodore L. Press, and Elizabeth C. Crouse
On July 23, 2014, the Securities and Exchange Commission (SEC) adopted final rules
governing the structure and operation of money market funds (SEC MMF Reform Rules).
See our client alert entitled “SEC Adopts Floating-NAV and Liquidity Fees/Redemption Gates
Rules for Money Funds” dated July 25, 2014. The SEC MMF Reform Rules will become
effective 60 days after their publication in the Federal Register. This client alert discusses
rules the U.S. Treasury Department (Treasury) and the Internal Revenue Service (IRS) have
adopted or proposed to deal with the tax treatment of money market funds subject to the
SEC MMF Reform Rules.
Floating-NAV Money Market Funds will not be subject to the wash sale rules.
Under the wash sale rules, a taxpayer may not recognize loss realized on the sale of stock or
securities if the taxpayer purchases substantially identical stock or securities within 30 days
before or after the sale. The taxpayer generally retains its old basis in the acquired stock or
securities in order to preserve the loss. Because money market funds have historically
sought to maintain a stable (typically at $1.00) net asset value per share (NAV), redemptions
of money market fund shares have not been subject to the wash sale rules because, with a
constant share price, redeeming shareholders could not recognize a loss.
The SEC MMF Reform Rules will require non-government institutional (i.e., not retail) money
market funds, including institutional tax-exempt money market funds, to price their shares
using the market values of portfolio securities (rather than the currently permitted amortized
cost and/or penny rounding methods) and to calculate their NAVs to the nearest 1% or four
decimal points. The share prices of funds subject to the SEC MMF Reform Rules thus are
expected to “float.” A redemption of shares in a money market fund that has a floating NAV
(Floating-NAV MMF) thus could produce a loss and potentially implicate the wash sale rules.
Revenue Procedure 2014-45, released on the same day as the SEC MMF Reform Rules,
however, provides that a Floating-NAV MMF will not be subject to the wash sale rules,
effective for redemptions of shares on or after the effective date of the SEC MMF Reform
Rules.
Under Revenue Procedure 2014-45, a taxpayer will be permitted to recognize loss on the
sale of Floating-NAV MMF shares even if the taxpayer purchases shares in the same
Floating-NAV MMF within the 30-day wash sale period. (Such purchases are quite common,
particularly if a shareholder elects to reinvest dividends.) To qualify for this exception, the
share issuer must be regulated as a money market fund under Rule 2a-7 under the
Investment Company Act of 1940, hold itself out to investors as a money market fund, and be
a Floating-NAV MMF. The Revenue Procedure is more permissive than the approach
proposed last year in an IRS notice when the SEC proposed the money market fund rule
amendments: the exception in the earlier notice only would have applied if redemptions did
not exceed a de minimis threshold.
New Tax Guidance Would Simplify Rules for Shareholders
of Institutional Money Market Funds
The IRS justified the approach taken in the Revenue Procedure based on the understanding
that the share prices of Floating-NAV MMFs will be relatively stable and that monitoring
Floating-NAV MMF transactions for wash sales would be unreasonably burdensome for
taxpayers. In the Revenue Procedure, the IRS did not indicate how it would treat FloatingNAV MMFs for any other purpose. However, the preamble to the proposed Treasury
regulations discussed below makes clear that any loss realized on the redemption of a
stable-value money market fund (for example, because of a liquidity fee that is treated as a
reduction in the redemption proceeds) will be subject to the wash sale rules.
Taxpayers may elect to account for dispositions of Floating-NAV MMF shares
on an aggregate basis.
Treasury and the IRS also issued proposed income tax regulations that will greatly simplify
the calculation of gain and loss realized on redemptions of Floating-NAV MMF shares.
Under the proposed “NAV method,” a taxpayer generally may calculate gain or loss based
on the change in the value of its Floating-NAV MMF shares between the beginning and end
of a “computation period.” The computation period may be the taxpayer’s taxable year or a
shorter period, but all computation periods must be approximately equal in length. The
character of the realized gain or loss will depend on the character of the underlying FloatingNAV MMF shares in the taxpayer’s hands, but any net capital gain or loss will be treated as
short-term. Dividends paid by Floating-NAV MMFs will be subject to federal income taxation
and information reporting in the same way as all other dividends.
A taxpayer may elect to use the NAV method simply by employing it in the taxpayer’s federal
income tax return for the first taxable year in which the taxpayer holds shares of a FloatingNAV MMF. The NAV method is considered an accounting method for tax purposes and, if
elected, must be applied to all Floating-NAV MMF shares owned by a taxpayer. Once that
method is elected, IRS approval is required to cease using it.
Although the proposed regulations regarding the NAV method will not apply until taxable
years beginning on or after the taxable year in which they are finalized, the regulations
expressly permit taxpayers to rely on them for taxable years ending on or after their
publication date.
Treasury and the IRS also requested comments on whether the NAV method should also be
available for shareholders in a stable-value money market fund, given that redeeming
shareholders in such a fund may also recognize gain or loss if the fund charges a liquidity
fee as permitted under the SEC MMF Reform Rules.
Like other money market funds, Floating-NAV MMFs will not need to issue
Form 1099 to redeeming shareholders.
Floating-NAV MMFs, like money market funds generally, also will be exempt from the
information-reporting requirements applicable to brokers, transfer agents, and certain issuers
of securities (including mutual funds) on Form 1099. The existing exemption for money
market funds that have a stable NAV is premised on the fact that a redeeming money market
fund shareholder will not recognize gain or loss because the share value is always the same.
Since the NAV of Floating-NAV MMF shares will vary and, thus, redemptions of those shares
may produce gain or loss, there was some concern that those transactions would be subject
to these information-reporting requirements.
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New Tax Guidance Would Simplify Rules for Shareholders
of Institutional Money Market Funds
The proposed regulations confirm that the reporting agents described above—including the
Floating-NAV MMFs themselves—are not required to issue Forms 1099 with respect to
transactions involving Floating-NAV MMF shares. Many shareholders of Floating-NAV
MMFs would not receive Forms 1099 anyway because they are exempt recipients under the
regulations; these include corporations, tax-exempt entities (including pension funds and
individual retirement accounts), governmental entities, financial institutions, and other
regulated investment companies.
Taxpayers and persons that would otherwise be required to issue Forms 1099 with respect
to securities transactions may rely on these proposed regulations on information reporting for
calendar years beginning prior to the date on which they are finalized.
Note that the proposed regulations affect only the information-reporting requirements and do
not alter the substantive tax rules that apply to redemptions. Thus, a shareholder redeeming
Floating-NAV MMF shares must still recognize and pay tax on gain realized in a redemption.
Authors:
Roger S. Wise
Theodore L. Press
Elizabeth C. Crouse
roger.wise@klgates.com
+1.202.778.9023
ted.press@klgates.com
+1.202.778.9025
elizabeth.crouse@klgates.com
+1.206.370.6793
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