IRS finalizes new rules for investors in money market funds
TAX ALERT |
The IRS has finalized regulations, originally proposed in July 2014, allowing investors in money market funds (MMFs) to compute gain or loss on their MMF investments periodically based on the net asset value (NAV) of the investments, as opposed to the traditional realization method.
These new regulations came as a response to changes in Securities and Exchange Commission (SEC) rules that partially prohibited certain techniques that MMFs used to keep a stable NAV of $1 per share. Under the old system, this stable $1 per share NAV meant that realizing a gain or loss on disposition of MMF shares was unlikely, absent an MMF in distress that could not maintain that share price. With the new SEC rules, however, MMF NAVs may fluctuate. In addition, redemption fees or limits may be required. These changes have the effect of making gain or loss on MMF dispositions, which can be very frequent, a common occurrence. The new regulations seek to simplify some of the administrative burden that this was expected to cause.
Under the NAV method provided for in the regulations, a taxpayer selects periods of either equal or varying length that together comprise the entirety of their taxable year (the computation periods). The taxpayer’s gain or loss from an MMF is, for each computation period, the published NAV as of the last day of the period, less the starting basis as of the first day of the period (either the previous period’s ending NAV or, in the first computation period, the taxpayer’s adjusted basis in the MMF shares), less the taxpayer’s net investment in the MMF (net investment being the total cost of shares purchased during the period less amounts received in redemption of shares during the same period). The character of the gain or loss is short-term capital gain or loss if, under the realization method, the sale of one or more shares of the MMF would give rise to capital gain or loss. Otherwise, the gain or loss is ordinary.
Taxpayers may elect to use the NAV method separately for each MMF interest they hold. A taxpayer who holds interests in an MMF through more than one account must treat the holdings in each account as a separate MMF for purposes of these rules. Therefore, taxpayers may use the NAV method for a MMF interest held in one account, but not for an interest in the same MMF held in a different account. Computation periods and character may also differ from MMF to MMF and account to account.
A change by a taxpayer to or from the NAV method is a change in method of accounting for tax years ending on or after July 8, 2016. Newly issued Rev. Proc. 2016-39 provides that this change is required to be made on a prospective ‘cut-off’ basis with no historical adjustment permitted. Under certain situations, taxpayers changing to the NAV method with stable-NAV MMFs may be able to effectuate this change without filing a Form 3115, Application for Change in Accounting Method. Otherwise, taxpayers are permitted to file a shortened version of Form 3115 under the automatic consent procedures, which does not require advanced IRS consent to file such changes. This welcomed transition guidance provides streamlined measures for taxpayers wishing to change to or from the NAV method of accounting, easing the administrative burden of making such changes under the new regulations.
Special rules apply in certain circumstances, particularly with respect to regulated investment companies (RICs). Taxpayers should consult their tax advisors if they are considering availing themselves of the NAV method for their MMF interests.