Prior to the Regulated Investment Company (RIC) Modernization Act of 2010, a RIC was often required to split its taxable year into pre-November and post-October periods. This was done for the purposes of calculating its net capital gain when it had net capital gain during the pre-November period and net capital loss during the post-October period, or, a bifurcation adjustment. Changes, provided by the RIC Modernization Act, to the requirements to defer late-year losses eliminated the need for RICs to continue to make these bifurcation adjustments in many cases. However, there are still situations to be aware of in which a RIC would continue to make the adjustment.
In Notice 2015-41, the IRS describes the situations where a bifurcation adjustment continues to apply. The notice also highlights the importance of proper designation for long-term capital gain characterizations by now requiring (previously optional) RICs to report specific amounts for each category of the long-term rate groups. The bifurcation adjustment is intended to preserve the integrity of classifications between differing rate groups — for example, the 28% rate group, 25% rate group and 20% rate group for capital gains — in instances where the pre-November and post-October realized gain/loss would result in different classifications when comparing the grouping results for the two periods separately versus for the fiscal year as a whole.
Specifically, the bifurcation adjustment applies when four conditions are met:
- When a fund has a fiscal year end other than October 31 or does not have an IRC Sec. 4982(e)(4) election in place,
- The fund has pre-November net capital gains,
- The fund has net capital loss in one or more long-term rate groups that would cause pre-November gain to be re-characterized (this occurs when a fund has less capital gain for the full taxable year than for the pre-November portion for a category), and
- There is no post-October capital loss deferral, which would alleviate such re-characterization.
Consider a June fiscal year-end RIC that has pre-November long-term capital gain of $100 in the 20% rate group, post-October long-term capital loss of $50 in the 20% category and long-term capital gains of $50 in the 25% rate group. Looking at the full fiscal year, the fund would have a net long-term capital gain for the year of $100, of which $50 would be of the 20% category (net of $100 pre-November capital gain and $50 post-October capital loss), and $50 would be of the 25% category. Notably, there is no post-October loss deferral available in this scenario. This does not yield the same designations if the RIC considered the pre-November and post-October periods separately.
The bifurcation adjustment applies in this situation. The gain or loss of the pre-November and post-October periods are netted separately, and the maximum amount of designation for each category for the year is the sum of the maximum amounts determined for each period. In the above scenario, the RIC would first look at the pre-November period and determine that the RIC has $100 of 20% long-term capital gains available for designation. Then considering the post-October period separately, the RIC would net the gain or loss of that period, which in this example is $0, and see that there are no designations for the period. Overall, the fund has a net long-term capital gain of $100 for the entire fiscal year, which is designated to the 20% category.
While the more widespread application of bifurcation on overall long-term and short-term items is largely obsolete, bifurcation continues to be appropriate in the reporting of the various long-term capital-gain rate groups. Talk with your tax advisors as to the applicability to your situation.
Please contact a member of your service team, or Rob Velotta at email@example.com for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.