In addition to the fiscal distribution requirements that govern Regulated Investment Companies (RICs) under Internal Revenue Code (IRC) Subchapter M, all RICs are required to comply with the excise tax rules under IRC Section 4982. The excise tax rules are intended to accelerate payment of tax to the U.S. treasury by requiring RICs to make a distribution earlier than would be required under Subchapter M.
Broadly speaking, RICs that fail to distribute the sum of the following three items will be subject to an excise tax liability equal to 4% of the undistributed amount:
Instead of using October 31 as the end of the measurement period for net capital gain, RICs with November and December year-ends have another option. The section 4982(e)(4) election allows these RICs to elect to have the measurement period for net capital gain match the RIC’s fiscal year-end.
IRC Section 4982(e)(4) provides generally that if a RIC’s tax year ends in November or December, and the RIC makes the 4982(e)(4) election, then the capital gain measurement period for excise purposes is applied by taking into account the company’s taxable year in lieu of the one-year period ending on October 31 of the calendar year.
For example, a RIC with a November tax year-end that makes the 4982(e)(4) election will calculate its excise tax distribution requirement using ordinary income for the calendar year and capital gain income through the end of November — eliminating the need to perform two separate capital gain distribution requirement calculations each year.
The election is made on Form 8613, Return of Excise Tax on Undistributed Income of Regulated Investment Companies, which must be filed by the 15th day of the third month following the end of the calendar year for which the election is to be applied (a six-month extension is allowed). Once made, the election is generally irrevocable without the consent of the Secretary of the Treasury.
This election eliminates the burden of calculating net capital gain income for two different time periods each year but may create additional administrative complexities. Namely, December year-end RICs using this election have a more onerous time constraint in calculating and making the required distribution because the distribution must be paid by December 31, which is the last day of the net capital gain measurement period for the election.
Additionally, any acquisitions in the 30 days following the calendar year-end could impact the distribution requirement by application of the wash sale rule. These are not known at the required distribution date. Fund managers could therefore find themselves in a position where they are limited in their ability to trade securities sold at a loss in the 30 days prior to year-end, or otherwise must be cognizant that any wash sales triggered could create or increase an excise tax liability.
The 4982(e)(4) election is irrevocable without IRS consent. However, there are two options a RIC could consider should it wish to revoke an election made in a previous tax year:
1) A RIC could seek to obtain a Private Letter Ruling from the IRS. This is a written statement the IRS issues directly to a taxpayer that interprets and applies tax laws to a taxpayer’s specific set of facts. IRS Private Letter Ruling 201934004 was recently issued to a RIC (May 24, 2019) consenting to the RIC’s request to revoke the 4982(e)(4) election. The Private Letter Ruling cited the facts they used to grant the request:
It should be noted that Private Letter Rulings are directed specifically to the taxpayer that requested it, and cannot be used or cited by other taxpayers as precedent. There are IRS service fees that accompany filing for these rulings, as well as uncertainty relating to if and when one will be issued.
2) A RIC also has the option of changing its tax year-end. Because the 4982(e)(4) election is available only to RICs whose tax year ends in November or December, the election is not available for RICs whose tax year falls outside of this time frame. Therefore, as a means of making a RIC’s 4982(e)(4) election invalid, a RIC could change its year-end to a month other than November or December. The RIC would then revert its excise year-end back to October 31 for net capital gain purposes. The change in tax year end is automatic upon filing Form 1128. RICs that consider changing their year-end for the purposes of eliminating the 4982(e)(4) election should be cognizant that another automatic change in year-end will not be allowed for five years following the change.
The 4982(e)(4) election can be an effective way of eliminating some administrative burden for RICs with November and December fiscal year-ends. However, the election may not be right for all situations. Any decisions related to the 4982(e)(4) election should be discussed with a RIC’s tax advisor.
Contact Patrick Grodach at email@example.com, Jay Laurila at firstname.lastname@example.org or a member of your service team to discuss this topic further.
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