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Tax Insights, May 11, 2016
Tracking Tax News You Need to Know

May 11, 2016
Publications
IRS Provides Relief for Certain Money Market Funds That Receive ‘Top Up’ Contribution
The IRS released Revenue Procedure 2016-31 to provide guidance to money market funds (MMFs) that receive contributions from their advisers as the MMFs transition to comply with Securities and Exchange Commission rules that change how MMF shares are priced. Revenue Procedure 2016-31 advises that if an MMF receives a contribution as part of a transition to implement the floating NAV reform before Oct. 14, the IRS will not challenge the MMF’s treatment of the contribution as an amount that is included in investment company taxable income (ICTI) for purposes of Section 852(b)(2) (section references are to the Internal Revenue Code of 1986, as amended), but it is excluded from ICTI for purposes of Section 852(a)(1).

The practical impact of the inclusion/exclusion dichotomy set forth in the revenue procedure is that the MMF pays federal income tax on the amount of the adviser contribution, but the MMF is not required to distribute the amount of the adviser’s contribution in order to qualify as a regulated investment company (RIC). Thus, the net contribution remaining after the payment of federal income tax by the MMF, assuming that the contribution includes the amount necessary for the MMF to pay federal income tax on the adviser contribution, is sufficient to raise the MMF’s NAV to $1.0000. 

The revenue procedure provides an example that includes a contribution from the adviser of an MMF that increases the MMF’s NAV to $1.0000. In the example, the adviser “grosses up” the contribution to the MMF so that the contribution is sufficient to cover the federal income tax that will be owed by the MMF. The net amount of the adviser’s contribution remaining after the payment of federal income tax by the MMF is sufficient to restore the MMF’s NAV to $1.0000. The revenue procedure indicates that for excise tax purposes, it is critical that the MMF elect under Section 4982(c)(4) to make estimated tax payments on the amount of its ICTI subject to tax during the calendar year in which the taxable year of the MMF begins to avoid the imposition of federal excise tax under Section 4982.

Revenue Procedure 2016-31 does not address the ability of the adviser to deduct its contribution to an MMF and does not address the state and local tax consequences, if any, of an adviser contribution to an MMF. The revenue procedure can be viewed as a safe harbor under which the IRS will not challenge the federal income and excise tax treatment of an adviser contribution to an MMF, provided that the MMF falls within the scope of the revenue procedure and the requirements of the revenue procedure are satisfied.

Under the Securities and Exchange Commission’s Money Market Fund Reform Rules amending Rule 2a-7 under the Investment Company Act of 1940, an MMF that is not a government MMF or a retail MMF must convert to a floating NAV MMF no later than Oct. 14. An MMF converting to a floating NAV may receive a contribution so that when the MMF transitions to a floating NAV, all shareholders receive the same value per share at the time of the transition (a “top up” contribution), e.g., a contribution from the adviser to the fund. RICs are required to meet certain income distribution requirements under Sections 852 and 4982. As the IRS highlights in the revenue procedure, if the distribution requirements apply to an adviser contribution, it may be impossible or impractical for the advisers of some MMFs to make contributions that raise the MMF’s NAVs to $1.0000, so that shareholders will receive the same value per share both before and after the transition to a floating NAV. If contributions from an adviser are subject to the distribution requirements, then to increase the value of an MMF’s portfolio by a given amount, an adviser may need to contribute more than 10 times that amount to “gross up” the contribution for both a 90 percent distribution requirement and the tax on the undistributed amount.

The Treasury Department and the IRS believe that it is in the interest of sound tax administration to apply Section 852 in a manner that will support the efforts of the staff of the SEC Division of Investment Management to facilitate a smooth transition to compliance with the SEC MMF Reform Rules. The Treasury Department and the IRS believe that excluding certain adviser contributions from ICTI for purposes of the distribution requirements in Section 852(a) is important to facilitate those contributions, but they do not believe the contributions should be excluded from the RIC’s income for other federal tax purposes.

IRS Issues Guidance to Government Funds for Section 817(h) Diversification Requirements
The IRS has issued Notice 2016-32, which provides guidance to taxpayers regarding the diversification requirements under Section 817(h) for a segregated asset account that invests in an MMF that is a government MMF. Rule 2a-7 defines a government MMF as an MMF “that invests 99.5 percent or more of its total assets in cash, government securities, and/or repurchase agreements that are collateralized fully [by cash items or government securities].” Under Section 817(h)(1), a variable contract (other than a pension plan contract [as defined in Section 818(a)]) that is otherwise described in Section 817 and is based on a segregated asset account shall not be treated as an annuity, endowment or life insurance contract for any period (and any subsequent period) for which the investments made by such account are not, in accordance with regulations prescribed by the Secretary, adequately diversified. Additionally, the policyholder must not have investor control either as a result of the ability to select among investment strategies or for any other reason. Treasury Regulations Section 1.817-5(b)(1)(i) describes specific percentages that a variable contract must satisfy in order to be considered “adequately diversified.” In applying the diversification requirement of Treasury Regulations Section 1.817-5(b), a look-through rule in Treasury Regulations Section 1.817-5(f) treats a segregated asset account as the owner of assets held indirectly through certain investment vehicles (certain RICs, certain REITs, certain partnerships or certain trusts). If one of these vehicles satisfies the criteria of Treasury Regulations Section 1.817-5(f)(2) (generally, all the beneficial interests in the RIC, partnership or trust are held by one or more segregated asset accounts of one or more insurance companies; and, generally, public access to such RIC, partnership or trust is available exclusively through the purchase of a variable contract), and if a segregated asset account holds an interest in the vehicle, diversification of the account is tested as if a pro rata portion of each asset of the vehicle were an asset of the account.

The notice explains that under current practice, only a limited number of United States agencies or instrumentalities issue securities that Rule 2a-7 allows MMFs to hold. Also, in coordination with the MMF Reform Rules described above, some MMFs are expected to convert to government MMFs, resulting in increased demand for government securities. This increased demand, the IRS notes, may exacerbate MMFs’ difficulty in acquiring the assets necessary both to qualify as a government MMF and to satisfy the diversification requirements under Section 817(h) and Treasury Regulations Section 1.817-5.

The Treasury Department and the IRS have determined that variable contracts should be able to offer government MMFs as an investment option. Therefore, the notice states, the Treasury Department and the IRS intend to amend Treasury Regulations Section 1.817-5. Pending the promulgation and effective date of future administrative or regulatory guidance, taxpayers may rely on the following alternative diversification requirement under Treasury Regulations Section 1.817-5 for a segregated asset account that invests in a government MMF:

A segregated asset account, within the meaning of Treasury Regulations Section 1.817-5(e), is adequately diversified for purposes of Section 817(h) if:
(1) No policyholder has investor control; and 
(2) Either: 
(a) The account itself is a government MMF under Rule 2a-7(a)(14); or
(b) The account invests all of its assets in an “investment company, partnership, or trust,” as defined in Treasury Regulations Section 1.817-5(f)(1), that satisfies the criteria of Treasury Regulations Section 1.817-5(f)(2) and qualifies as a government MMF under Rule 2a-7(a)(14).

IRS Revises Procedures, Increases Fee for Prefiling Agreements
The IRS released Revenue Procedure 2016-30; 2016-21 I.R.B. 1, which permits a taxpayer under the jurisdiction of the Large Business and International (LB&I) Division to request that the IRS examine specific issues relating to tax returns before those returns are filed. The revenue procedure modifies and supersedes Revenue Procedure 2009-14, 2009-3 I.R.B. 324. The revenue procedure outlines the procedures for resolving issues through prefiling examinations, which, as the revenue procedure notes, enables taxpayers and the IRS to resolve issues more effectively and efficiently than a post-filing examination, because the taxpayer and the IRS have more timely access to the records and personnel relevant to the issues. Further, a prefiling examination also provides the taxpayer with certainty regarding the examined issue at an earlier point than a post-filing examination. The IRS expects that these procedures will benefit both taxpayers and the IRS by improving the quality of tax compliance while reducing costs, burdens and delays. The revenue procedure authorizes the taxpayer and the IRS to memorialize their agreement by executing an LB&I Pre-Filing Agreement (PFA). Unlike letter rulings and other forms of written advice provided by the Offices of the Associate Chief Counsels, a PFA does not determine the tax treatment of prospective or future transactions or events but only of completed transactions or events whose tax treatment has not yet been reported on a return. Additionally, the current user fee of $50,000 for taxpayers selected to participate in the PFA program will increase to $134,300 for PFA requests submitted on or after June 3 and to $218,600 for PFA requests submitted on or after Jan. 1, 2017.

Temp Regulations Clarify Self-Employment Tax Treatment of Some Partners
The IRS has published final and temporary regulations (T.D. 9766) that clarify the employment tax treatment of partners in a partnership that owns a disregarded entity. The text of the temporary regulations serves as the text of proposed regulations. The Treasury Department and the IRS clarify in the temporary regulations that the rule that a disregarded entity is treated as a corporation for employment tax purposes does not apply to the self-employment tax treatment of any individuals who are partners in a partnership that owns a disregarded entity. The rule that the entity is disregarded for self-employment tax purposes applies to partners in the same way that it applies to a sole proprietor/owner. Accordingly, the partners are subject to the same self-employment tax rules as partners in a partnership that does not own a disregarded entity. In order to allow adequate time for partnerships to make necessary payroll and benefit plan adjustments, these temporary regulations will apply on the later of (1) Aug. 1; or (2) the first day of the latest-starting plan year of an “affected plan,” following May 4 (based on the plans adopted before, and the plan years in effect as of, May 4) sponsored by an entity that is disregarded as an entity separate from its owner for any purpose under Treasury Regulations Section 301.7701–2.

IRS Provides Automatic Changes List for Accounting Methods
The IRS has provided Revenue Procedure 2016-29, the list of automatic changes to which the automatic change procedures in Revenue Procedure 2015-13, 2015-5 I.R.B. 419, as clarified and modified by Revenue Procedure 2015-33, 2015-24 I.R.B. 1067, and as modified by Revenue Procedure 2016-1, 2016-1 I.R.B. 1 (or successor), apply.

2016 Panama-US FATCA Agreement Available
The text is available of the agreement signed by Panama and the United States to improve international tax compliance and implement the information reporting and withholding tax provisions of the Foreign Account Tax Compliance Act.

IRS Issues 2016 Form 1042-S, Instructions
The IRS has issued 2016 Form 1042-S, Foreign Persons’ U.S. Source Income Subject to Withholding, and the instructions for that form. The form requests additional information as compared to the 2015 form.

Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.

Copyright © 2016 Stradley Ronon Stevens & Young, LLP. All rights reserved.

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