Regulated Investment Companies (RICs) regularly invest in entities classified as partnerships for U.S. tax purposes. It is important for RIC managers to understand the different types of partnership investments, most notably whether or not a publicly traded partnership (PTP) you may be investing in is treated as a qualified publicly traded partnership (QPTP). Knowing how to identify QPTPs is critical to ensuring your investment in one does not result in the loss of your RIC status.

What Qualifies as a Publicly Traded Partnership for Tax Purposes?

Partnership investments are generally considered either private partnerships or PTPs for federal income tax purposes. A PTP must meet certain requirements:

1. The partnership interests are traded on an established securities market or are readily tradable on a secondary market (or a substantial equivalent); and
2. At least 90% of a PTP’s gross income must be from interest, dividends, rent from real property, or gains from sale of real property; or income/gains from the exploration, development, mining or production, processing, refining, transportation or marketing of natural resources.

A PTP that does not meet these requirements is considered a corporation for tax purposes.

What Is a Publicly Traded Partnership’s Impact on RIC Qualification? (a.k.a Qualifying Income and Asset Diversification Tests)

Partnership investments affect a RIC’s compliance with Subchapter M in two main ways: the qualifying income test and the asset diversification test.

Qualifying Income Test

The qualifying income test requires at least 90% of a RIC’s gross income be derived from:

1. Dividends, interest, payments with respect to securities loans; gains from the disposition of stock, securities or foreign currencies; or other income derived with respect to its business of investing in such stock, securities or currencies; or
2. Net income derived from an interest in a QPTP.

A PTP that does NOT meet the income requirements above qualifies as a QPTP for tax purposes; a PTP that meets the income requirements is simply considered a PTP.

For the qualifying income test, net income derived from an interest in a QPTP is considered qualifying income. However, for PTPs and private partnerships, a RIC must look through to the gross income of the underlying partnerships to determine how much of the partnership’s income is qualified. A RIC must include its pro rata share of the private partnership or PTP’s income as if the RIC received it directly. Since a nonqualifying PTP must meet the same gross income requirements as a RIC, as discussed above, at least 90% of its gross income should be qualifying for the RIC. Investments in private partnerships must be monitored closely, as they can expose a RIC to nonqualified income.

Asset Diversification Test

For the asset diversification tests, there are a few considerations:

• A RIC’s investment in one or more QPTPs cannot exceed 25% of the RIC’s total assets.
• Any one QPTP that represents greater than 5% of the RIC’s total assets or 10% of the QPTP’s outstanding voting securities is considered a nonqualifying asset for purposes of the 50% qualification test.
  • For this test, any nonqualifying QPTP investment, in addition to any other nonqualifying assets for the 50% test (generally securities that are greater than 5% of a RIC’s total assets), cannot exceed 50% of total assets at the end of any quarter of the RIC’s taxable year.
• For PTPs and private partnerships, a RIC must look through to the underlying assets of the partnership, on a pro rata basis, and use those assets in determining their qualification.
  • Generally, PTPs are investment partnerships that hold qualifying assets for purposes of RIC qualification.

What is the Best Way RIC Managers Can Remain Compliant?

When it comes down to it, a RIC has various options when gaining exposure to partnership investments but must ensure it continues to comply with Subchapter M at all times. Regularly analyze any partnership investments to ensure tax classifications are correct.

Contact James Augustine at jaugustine@cohencpa.com or a member of your service team to discuss this topic further.

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.