Final US Treasury Regulations Provide Additional Flexibility in Determining the Tax Implications of Money Market Fund Share Transactions

Final U.S. Treasury regulations under Section 446 of the Internal Revenue Code of 1986, as amended (the “Code’), providing for the use of the net asset value (“NAV”) accounting method for transactions in money market fund (“MMF”) shares were released on July 8, 2016 (the “Final Regulations”).¹ 

The Final Regulations were released in advance of the October 14, 2016 date by which certain MMFs are required to adopt a floating net asset value (“FNAV”) in accordance with the 2014 amendments to Rule 2a-7 under the Investment Company Act of 1940, as amended (the “1940 Act”). With the exception of an MMF that qualifies as a “government MMF” or a “retail MMF,”² Rule 2a-7 requires an MMF to calculate its FNAVs to the nearest one-hundredth of one cent (e.g., US$1.0000) based on the current fair value of its underlying investments. Eligible government MMFs and retail MMFs would continue to compute their NAVs based on the amortized cost of their underlying investments and, as such, generally would be permitted to maintain a stable NAV. 

The Final Regulations continue to permit the use of a simplified method of accounting (i.e., the “NAV Method”) for shares of FNAV MMFs, consistent with the methodology included in the proposed U.S. Treasury Regulations released in 2014 (the “Proposed Regulations”).³ Under the NAV Method, a taxpayer’s net gain or loss from transactions in shares in an MMF during a computation period (which may be the taxpayer’s taxable year or certain shorter periods) would generally equal the value of the taxpayer’s MMF shares at the end of the computation period, minus the value of the taxpayer’s MMF shares at the end of the prior computation period, reduced by the taxpayer’s net investment in the MMF during the computation period. In this regard, the NAV Method intends to streamline tax computations by basing them on the aggregate of all transactions in a period and on aggregate fair market values.⁴ The Proposed Regulations also would have required a taxpayer to apply the NAV Method to all FNAV MMF transactions conducted in all FNAV MMFs engaged in by the taxpayer, as well as in all such accounts held by the taxpayer. 

Contemporaneous with the Proposed Regulations, the Internal Revenue Service (the “Service”) and the U.S. Treasury Department (the “Treasury”) issued Revenue Procedure 2014-45, 2014-34 I.R.B. 388, which provided that the wash sale rules under Section 1091 of the Code would not be applied to any loss realized on the redemption of shares of an FNAV MMF, as long as the FNAV MMF is regulated by Rule 2a-7, under the 1940 Act and qualified as such at the time of the share redemption. In approving the 2014 amendments to Rule 2a-7, several Commissioners of the Securities and Exchange Commission (the “Commission”) specifically based their support of the FNAV requirement on the assumption that the Service and the Treasury ultimately would eliminate the application of the wash sale rules and adopt a simplified method for tracking gains and losses for transactions in FNAV MMFs. The exemption from the wash sale rules for qualifying FNAV MMF share redemption transactions provided by Revenue Procedure 2014-45 applied to FNAV MMF share redemptions conducted 60 days after August 14, 2014 (i.e., the effective date of the 2014 amendments to Rule 2a-7 adopted by the Commission). 

The Final Regulations contain several significant enhancements and clarifications to the guidance contained in the Proposed Regulations, including the following: 

• The Final Regulations also allow use of the NAV method for shares of stable-NAV MMFs, which may be appropriate where the stable-NAV MMF imposes liquidity fees or where shares in the stable-NAV MMF may be redeemed at a price other than the target price (e.g., where the MMF “breaks the buck”). 
• The Final Regulations remove the consistency requirement contained in the Proposed Regulations, so that taxpayers may now use different accounting methods to account for shares in different MMFs or for shares in a single MMF held in different accounts. 
• The Final Regulations provide that a regulated investment company (“RIC”) adopting the NAV Method for its own investments in MMF shares would be required to be consistent in applying the NAV method to such MMF shares for both income tax purposes and its own excise tax distribution requirements. 

Simultaneous with the release of the Final Regulations, the Service issued Revenue Procedure 2016-39,⁵ which provides rules about how taxpayers can obtain automatic permission to change to and from the NAV Method. Depending on the circumstances, a taxpayer may be able to change to the NAV Method merely by reporting MMF share transactional activity using the NAV Method on a tax return; otherwise, the taxpayer may be required to disclose such change of accounting method by filing a Form 3115, Application for Change in Accounting Method, with the Service. The Final Regulations are effective for taxable years ending on or after July 8, 2016, and taxpayers may rely on either the Final Regulations or on the Proposed Regulations for taxable years ending on or after July 28, 2014 and before July 8, 2016. 

Footnotes 

_{1) Section 1.446-7 of the Treasury Regulations, T.D. 9774, 2016-30 I.R.B. 151, 81 Fed. Reg. 44508 (July 8, 2016).
2) For purposes of applying the principles of Rule 2a-7 under the 1940 Act, a government MMF is defined in Rule 2a-7(a)(14) as an MMF that invests 99.5% or more of its total assets in cash, U.S. government securities (as defined in Section 2(a)(16) of the 1940 Act) and/or repurchase agreements “collateralized fully” in cash or government securities. A retail MMF is defined in Rule 2a-7(a)(21) as an MMF that “… has policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons.”
3) REG 107012-14, 2014-33 I.R.B. 371, 79 Fed. Reg. 43694 (July 28, 2014). 
4) The NAV Method takes into account changes in the aggregate value of MMF shares without regard to any gains or losses realized from MMF share redemption transactions. Any net gain or loss determined under the NAV Method is generally treated as a short-term capital gain or loss. Dividends distributed by an MMF continue to be recognized as ordinary dividend income, and a taxpayer’s reinvested dividends are taken into account in determining the taxpayer’s net investment in the MMF shares during the computation period.
5) Rev. Proc. 2016-39, 2016-30 I.R.B. 164 (July 25, 2016).}