Guidance Issued on NAV Method of Accounting for Money Market Funds

(Parker Tax Publishing July 2016)

The IRS has issued final regulations that provide a simplified method of accounting for gains and losses on shares in money market funds (MMFs). In addition, the IRS has issued a revenue procedure that describes how taxpayers may obtain automatic IRS consent to change to or from the net asset value (NAV) method of accounting for gain or loss on shares in an MMF. T.D. 9774 (7/8/16); Rev. Proc. 2016-39.

Background

A money market fund (MMF) is a type of investment company registered under the Investment Company Act of 1940 (1940 Act) and regulated as an MMF under Rule 2a-7 under the 1940 Act. The securities that Rule 2a-7 permits an MMF to hold generally result in no more than minimal fluctuations in the MMF's net asset value per share (NAV). Unlike other types of mutual funds, MMFs have historically sought to keep stable (typically at $1.00) the prices at which their shares are distributed, redeemed, and repurchased.

In 2014, the Securities and Exchange Commission (SEC) issued rules that changed the amount for which certain MMF shares are distributed, redeemed, and repurchased (SEC MMF Reform Rules). The SEC MMF Reform Rules generally bar the use of the amortized cost method and penny rounding for certain MMFs (floating-NAV MMFs) and require a floating-NAV MMF to value its assets using market factors and to round its price per share to the nearest basis point. However, the rules allow certain other MMFs (stable-NAV MMFs), generally the beneficial owners of which are limited to natural persons, to continue to use the amortized cost method and penny rounding. The rules also establish circumstances under which an MMF is permitted or required to impose a liquidity fee or is permitted to impose a redemption gate.

The IRS has now issued final regulations under Code Secs. 446 and 6045 that are intended to simplify tax compliance for holders of shares in MMFs affected by the SEC MMF Reform Rules, and describe a simplified method of accounting for gain or loss on shares in a floating-NAV MMF (the NAV method). Procedures for obtaining automatic consent to change to or from the NAV method are provided in Rev. Proc. 2016-39. The regulations and the revenue procedure are effective on July 8, 2016.

Summary of the Final Regulations

The final regulations provide that under the NAV method, a taxpayer's gain or loss on shares in an MMF is based on the change in the aggregate value of the taxpayer's shares during a computation period selected by the taxpayer and on the net amount of the purchases and redemptions during the computation period.

The final regulations also:

(1) permit taxpayers to apply the NAV method to shares in stable-NAV MMFs;

(2) permit MMF shareholders to use different methods of accounting for shares in different MMFs or for shares in a single MMF held in different accounts;

(3) generally require a real estate investment company (RIC) to use the NAV method either for both income tax and excise tax computations or for neither computation;

(4) clarify that the fair market value of a share in an MMF at the time of a transaction is presumed to be the published NAV;

(5) include provisions for determining the amount received in redemption of MMF shares for purposes of computing a taxpayer's net investment in an MMF for a computation period;

(6) clarify the effect on net investment of a share acquired from another person with a transferred basis; and

(7) provide that if the sale of all of the shares in the MMF would give rise to a combination of ordinary gain or loss and capital gain or loss if sold or exchanged in a computation period, then all gain or loss from the shares in the MMF is treated as capital gain or loss.

Automatic Consent Procedures to Change to or from the NAV Method

In Rev. Proc. 2016-39, the IRS issued the procedures by which a taxpayer may obtain automatic consent to change to or from the NAV method for shares in an MMF.

In certain circumstances, Rev. Proc. 2016-39 permits taxpayers to change to the NAV method on a federal tax return without filing a Form 3115, Application for Change in Accounting Method. This simplified procedure applies to a taxpayer that holds shares in a stable-NAV MMF and wants to change to the NAV method for a taxable year if:

(1) the taxpayer has not used the NAV method for shares in the MMF for any taxable year prior to the year of change, and

(2) prior to the beginning of the year of change, either the taxpayer's basis in each share of the MMF has been at all times equal to the MMF's target share price, or the taxpayer has not realized any gain or loss with respect to shares in the MMF.

For certain other changes, Rev. Proc. 2016-39 provides automatic consent procedures that require a short Form 3115. For example, these automatic consent procedures apply to a taxpayer that:

(1) has adopted a realization method for shares in a floating-NAV MMF and wants to change to the NAV method for shares in that MMF, or

(2) has adopted the NAV method for shares in a floating-NAV MMF and wants to change to a permissible realization method for shares in that MMF.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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