United States: IRS Issues Guidance Package Related To Money Market Funds

The IRS on July 23 issued proposed regulations under Section 446 providing a simplified method of accounting for gains and losses on shares in a money market fund (MMF) as well as a revenue procedure outlining when the wash-sale rules under Section 1091 won't apply to redemptions of shares in an MMF.

The IRS guidance came the same day the SEC approved a rule requiring certain institutional prime MMFs (floating MMFs) to move to a floating net asset value (NAV) from a $1 per share NAV.

An MMF is a type of investment company registered under the Investment Company Act of 1940. Unlike other types of mutual funds, MMFs have historically maintained stable prices at which their shares are issued and redeemed, typically at $1 per share (constant price). The types of securities that MMFs are permitted to hold and their share-pricing and valuation methods have made constant prices possible.

The perceived safety and simplicity of MMFs have led to their use as cash management vehicles for investors. So, investors commonly purchase and redeem MMF shares frequently. However, because MMFs have historically been issued and redeemed at constant prices, an MMF shareholder generally wouldn't have realized gain or loss when redeeming an MMF share.

By requiring floating MMFs to issue and redeem shares at a price that changes regularly, shareholders will typically recognize gain or loss on redemptions of floating MMFs, unlike before, when prices were constant. The SEC received comments that expressed concern that the frequent purchases and redemption of floating MMF shares combined with relatively small changes in share values could result in tax compliance burdens disproportionate to the amounts of gain or loss.

Under the proposed regulations (REG-107012-14), taxpayers may use the "NAV method" to determine gain or loss for a taxable year related to shares of a floating MMF. Under Prop. Treas. Reg. Sec. 1.446-7(c), the NAV method computes net gain or loss for each "computational period" equal to the ending value of shares of a particular floating MMF minus the starting basis of the floating MMF shares, minus "net investment" in the floating MMF during the computational period. The computational period may be the taxable year or a shorter period — for example, a month or a week.

A taxpayer's gain or loss related to floating MMF shares under the NAV method is capital if the underlying floating MMF shares would otherwise give rise to capital gain or loss. Similarly, a taxpayer's gain or loss related to floating MMF shares under the NAV method is ordinary if the underlying floating MMF shares would otherwise give rise to ordinary gain or loss. Prop. Treas. Reg. Sec. 1.446-7(c)(3).

The IRS also issued Prop. Treas. Reg. Sec. 1.6045-1(c)(3)(iv), which provides that no return of information is required regarding a sale of shares of a MMF.

The proposed regulations are generally effective when final regulations are adopted.

In addition, the IRS issued Rev. Proc. 2014-45, which provides procedures for when the Section 1091 wash-sale rule will not apply to the redemption of shares of an MMF.

The wash-sale rule disallows a loss realized by a taxpayer on a sale or disposition of stock or securities if the taxpayer acquires, or enters into a contract to acquire, substantially identical stock or securities, and the acquisition or contract is entered into within a period beginning 30 days before and ending 30 days after the date of the sale or disposition.

Because investors may purchase and redeem MMF shares frequently, Section 1091 could apply to disallow a loss realized by a redeeming investor. As noted previously, the IRS issued Prop. Treas. Reg. Sec. 1.446-7, which allows taxpayers to use the NAV method to aggregate gain or loss related to redemptions of a floating MMF during a computational period. Because the NAV method provides for no gain or loss for any particular redemption during a computational period, the NAV method would not implicate the wash-sale rule. However, a shareholder of a floating MMF that doesn't use the NAV method may typically experience frequent wash sales.

Rev. Proc. 2014-45 says that the IRS won't treat a redemption of an MMF as part of a wash sale if the MMF constituted a floating MMF at the time of the redemption.

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