Taxation of Regulated Investment Companies (Portfolio 740)
This Portfolio discusses §§851 through 855, 860, and 4982 of the Internal Revenue Code, which govern the taxation of regulated investment companies and the tax issues of mutual funds.
Bloomberg Tax Portfolio, Taxation of Regulated Investment Companies, discusses in detail the provisions of §851 through 855, 860 and 4982 of the Internal Revenue Code, which govern the taxation of regulated investment companies (RICs). The Portfolio also discusses the applicability of other Code provisions to RICs.
The RIC provisions provide special favorable rules relating to the taxation of RICs. A domestic corporation (or entity that would otherwise be taxed as a corporation) registered with the Securities and Exchange Commission as an investment company under the provisions of the Investment Company Act of 1940 may elect to be a RIC for any taxable year in which it satisfies certain requirements relating to the source of its income and the diversification of its assets. A RIC that satisfies certain additional distribution requirements will generally be taxed as a pass-through entity that acts as a partial “conduit” of income to its shareholders. Such conduit treatment is achieved by allowing a qualifying RIC to deduct the amount of dividends paid to its shareholders in computing the RIC’s taxable income and gains, with the result that the RIC’s distributed net income and gains can be passed through to its shareholders free of tax at the RIC level.
A RIC can also pass through the character of its long-term capital gain income to the shareholders by paying “capital gain dividends” and, in certain circumstances, the character of tax-exempt interest income can also be passed through to the shareholders on the payment of “exempt-interest dividends.” Under certain conditions, a RIC may also pass through to its shareholder the ability to take the foreign tax credit (or deduction) with respect to foreign taxes paid by the RIC and the RIC’s credits from tax credit bonds and, in certain years, may pass through to some foreign persons exclusions from taxation of interest income and short-term capital gain. The corporate shareholders may also be able to obtain the benefit of the corporate dividends received deduction to the extent of the RIC’s income from qualifying dividends. Further, in some circumstances, dividends that shareholders receive from a RIC may be “qualified dividend income,” which may be eligible for taxation to individual shareholders at long-term capital gain rates.
Table of Contents
II. Historical Background
III. Types of Entities that Can Qualify for RIC Status
IV. Election of RIC Status
V. Source of Income Requirement
VI. Diversification Requirements
VII. Distribution Requirements for Taxation of RICs as Conduits
VIII. General Tax Treatment of Qualifying RICs and Shareholders
IX. Conduit Treatment of Long-Term Capital Gains
X. Conduit Treatment of Tax-Exempt Interest Income: §852(b)(5)
XI. Conduit Treatment of Foreign Tax Credit: §853
XII. Conduit Treatment of Dividends Received Deduction and Qualified Dividend Income: § 854
XIII. Short-Term Capital Gain Dividends
XIV. Interest-Related Dividends
XV. Section 852(b)(7): Dividends Paid in January that are Declared in the Prior Calendar Quarter
XVI. Dividends Paid by a RIC After the Close of Taxable Year: §855
XVII. Deficiency Dividends: §860
XVIII. Excise Tax on Failure to Satisfy Calendar Year Distribution Requirements: §4982
XIX. Taxation of Shareholders of RICs
XX. Series Funds
XXI. Master-Feeder Structures
XXII. Disallowance of Indirect Deductions by Shareholders for Certain Expenses of Nonpublicly
XXIII. Special Rules Applicable to Subchapter C Corporations Electing RIC Status and to
XXIV. Former Short-Short Test Under Former §851(b)(3)