Tax Accounting
In July, the SEC changed various rules on how certain money market fund (MMF) shares are valued. As a result of these changes, the IRS issued two items of related guidance. The first, effective July 28, 2014, provides a simplified method for tax reporting purposes of accounting to track gains and losses for redemptions of shares in MMFs affected by the new SEC rules (REG-107012-14). The second provides an exemption from the traditional wash-sale rules for certain redemptions of shares in MMFs affected by the new SEC rules (Rev. Proc. 2014-45).
Background on Money Market Funds
MMFs are a type of equity investment that typically seeks to provide investors with stable, low-risk returns in the short term, while sustaining a net asset value (NAV) of $1 per share. An MMF's portfolio normally consists of an investment in securities that are well-diversified, high-quality, and liquid, and provide insignificant fluctuations in the MMF's NAV per share. Investors receive dividends, often daily, which are then automatically reinvested back into the fund immediately. MMFs are often considered to be very safe and simple types of investments, leading to their popularity among investors that wish to use them as a cash management tool for short-term purposes. As a result of this easy access to cash and liquid investments, the buying and selling of MMF shares by investors occurs quite frequently, usually multiple times per day. Because of the low risk involved with investing in an MMF, investors are afforded a safe and stable short-term investment instrument that typically produces low returns.
SEC Money Market Fund Reform Rules
On July 23, 2014, the SEC adopted new rules that govern MMFs. The goal of the rules is to prevent investors from withdrawing their investments in MMFs, especially during challenging economic times, by requiring the funds to measure their NAV more accurately. Institutional prime MMFs, which historically have a fixed NAV of $1 per share, will now have a floating NAV, which means share prices will fluctuate daily. Specifically, securities will need to be valued based on their current market value rounded to the fourth decimal place (e.g., $1.0000). Also included in the final rules will be additional diversification disclosure requirements and stress-testing requirements, along with new MMF reporting rules. The SEC will provide a two-year transition period for funds and investors to allow both enough time to adjust their operations and investing activities. Along with the SEC's new rulings on MMFs, the IRS issued these two sets of guidance: (1) to make accounting for gains and losses on redemptions of shares in floating-NAV MMFs simpler and (2) to provide an exemption from the Sec. 1091 wash-sale rules.
Prop. Regs. Sec. 1.446-7
The IRS issued Prop. Regs. Sec. 1.446-7, which provides a simplified method of accounting for gains and losses for tax reporting purposes that eliminates the need to track individual purchase and redemption transactions. Gains and losses can now be tracked in aggregate during a "computation period," as opposed to individually tracking each transaction. The proposed regulations define a computation period as "the period that a taxpayer selects for computing gain and loss under the NAV method for a floating-NAV MMF." This period can be the taxpayer's tax year or a shorter period, including months, weeks, days, or as long or short as the taxpayer selects, provided each computation period is of an approximately equal duration (except for initial or final computation periods in a tax year), every day during a tax year falls within one, and only one, computation period, and each computation period contains days from only one tax year. The method of accounting allowed in the proposed regulations makes it simpler for taxpayers to track their gain and loss transactions, and can be used starting on July 28, 2014.
Rev. Proc. 2014-45
Under Sec. 1091 (loss from wash sales of stock or securities), taxpayers are not allowed a deduction for an equity security that is sold at a loss when "substantially identical stock or securities" are purchased either 30 days before or 30 days after the date of the sale. This affects all types of equity investments, including mutual funds, MMFs, and over-the-counter trading. Because Prop. Regs. Sec. 1.446-7 allows the tracking of gains and losses in the aggregate for redemptions of shares in floating-NAV MMFs, shareholders in floating-NAV MMFs that use this method of accounting will not have losses on an individual security level, so the wash-sale rules will not be triggered. However, if a shareholder in a floating-NAV MMF does not use this method of accounting, the shareholder will likely have frequent wash sales, because shares in the MMF are typically bought and redeemed multiple times per day.
To provide relief for these shareholders, Rev. Proc. 2014-45 provides that the IRS will not treat a redemption of a floating-NAV MMF share as part of a wash sale under Sec. 1091. However, this rule applies only if both of the following conditions are met: (1) The investment company is structured as an MMF regulated under Rule 2a-7 and holds itself out as an MMF; and (2) the investment company is a floating-NAV MMF at the time of repurchase of the stock.
Conclusion
As a result of recent SEC rule changes related to MMFs, these proposed regulations will benefit taxpayers by creating efficiencies, saving time, and minimizing costs in calculating gains and losses on transactions within an MMF. The simplified method of accounting in Prop. Regs. Sec. 1.446-7 is available to be used for tax years ending on or after July 28, 2014, and beginning before the date final regulations are published. Rev. Proc. 2014-45 allows for losses from redemptions of shares in floating-NAV MMFs to be exempt from the wash-sale rules. Rev. Proc. 2014-45 became effective for redemptions on or after the effective date of the new SEC MMF rules, which was Oct. 14, 2014.
EditorNotes
Mark Cook is a partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-422-7244 or mcook@singerlewak.com.
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.
