IRS Revenue Procedure
2002-16

Code Secs. 103, 702, 706, 707, 851, 852



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26 CFR 601.105: Examination of returns and claims for refund, credit, or
abatement; determination of correct tax liability.
(Also Part I, sections 103, 702, 706, 707, 851, 852; 1.706-1.)


REV. PROC. 2002-16

SECTION 1. PURPOSE

This revenue procedure allows certain partnerships that invest in
assets exempt from taxation under section 103 of the Internal Revenue Code
to make an election that enables money market fund partners to take into
account monthly the inclusions required under sections 702 and 707(c).


SECTION 2. BACKGROUND

Certain money market funds seek investments with a yield that reflects
current short-term exempt interest rates and that is treated for federal
income tax purposes as being composed of interest exempt from tax under
section 103. For purposes of this revenue procedure, a money market fund
is a fund described in the Securities and Exchange Commission's Rule 2a-7
(Rule 2a-7), 17 CFR 270.2a-7, issued under the Investment Company Act of
1940, 15 U.S.C. 80a-1 et seq. One investment that offers these advantages
is an instrument that might be described as a synthetic tax-exempt
variable-rate bond. To create such an instrument, a sponsor or an
affiliate (the Sponsor) purchases (either at original issue or on the
secondary market) an obligation the interest income on which is excluded
under section 103 (section 103 obligation) and transfers the section 103
obligation to an entity that qualifies as a partnership for federal tax
purposes (tax-exempt bond partnership). The tax-exempt bond partnership
issues two classes of equity interests: a preferred interest that is
entitled to a variable return on its capital contribution (preferred
interest), and a second class of ownership interest that is entitled to
all of the remaining income of the partnership (residual interest). The
variable return on the preferred interest tracks current short-term exempt
yields.

Under section 702(b), if a partnership receives income that is exempt
from tax under section 103, the income retains its character when the
partnership allocates it to a partner. Under section 706(a), a partner
includes in taxable income for a taxable year the partner's allocable
share of items of partnership income, gain, loss, deduction, and credit
for the partnership's taxable year ending within or with the partner's
taxable year.

Section 852(a) provides generally that a regulated investment company
(RIC), including a RIC that is a money market fund, must distribute each
taxable year at least 90 percent of its net interest income that is
excludible from gross income under section 103(a). Section 852(b)(5)
provides that if, at the close of each quarter of the RIC's taxable year,
at least 50 percent of the value (as defined in section 851(c)(4)) of the
total assets of the RIC consists of obligations described in section
103(a), the RIC is qualified to pay exempt-interest dividends (as defined
in section 852(b)(5)(A)) to its shareholders. Under section 852(b)(5)(A),
an exempt-interest dividend means any dividend or part thereof paid by a
RIC and designated by the RIC as an exempt-interest dividend in a written
notice mailed to its shareholders not later than 60 days after the close
of the RIC's taxable year.

To maintain a constant net asset value for each share of stock, as is
described in Rule 2a-7, money market funds commonly declare dividends
daily and pay dividends monthly. (In this paragraph and the next, the word
"dividend" refers to a distribution that is treated as a dividend for
purposes of state corporate law and federal securities law, whether or not
the distribution is also treated as a dividend for purposes of the Code.)
In the case of a money market fund that intends to pay exempt interest
dividends, substantially all of the fund's income typically will be exempt
from tax under section 103. If, however, such a money market fund has a
taxable year that differs from that of a tax-exempt bond partnership in
which it holds an interest, there may be a mismatch between the money
market fund's monthly distribution of income and the money market fund's
inclusion of its distributive share of partnership income under section
706(a). As a result, the money market fund's distribution of tax-exempt
income may be treated as a return of capital. Alternatively, the money
market fund may distribute less than its entire distributive share of
partnership income for the taxable year.

For example, assume that on January 2, 2002, a money market fund with a
taxable year ending June 30 acquires a preferred interest in a tax-exempt
bond partnership with a taxable year ending December 31. Under section
706(a), the money market fund's distributive share of the tax-exempt bond
partnership's income for the money market fund's taxable year ending June
30, 2002, is zero. If the money market fund's daily dividends do not
reflect its portion of the interest that the partnership earns between
January 2 and June 30, the fund will be unable to maintain a constant net
asset value for each share of its stock. (Whether or not the tax-exempt
bond partnership distributes the exempt interest to the money market fund
as that interest is earned, the per share net asset value of the fund will
rise if the fund does not make continual distributions to its shareholders
to reflect those partnership earnings.) On the other hand, if the money
market fund's daily dividends are based in part on the income earned by
the partnership between January 2, 2002, and June 30, 2002, the
distributions made by the money market fund during its taxable year ending
June 30, 2002, will exceed the includible tax-exempt income for the year,
causing all or a portion of those distributions to be characterized as a
return of capital.

The Treasury Department and the Internal Revenue Service have
determined that it is in the best interest of sound tax administration to
allow certain money market funds to take into account on a monthly basis
their distributive shares of partnership items if the partnership makes a
proper election under this revenue procedure.


SECTION 3. SCOPE

This revenue procedure applies to eligible partnerships (described in
section 3.01 of this revenue procedure) that elect to close their books
monthly (the Monthly Closing Election) and to eligible partners (described
in section 3.02 of this revenue procedure) that consent to take into
account their distributive shares of partnership income on a monthly basis
(the Monthly Closing Consent).

.01 ELIGIBLE PARTNERSHIP.

(1) GENERALLY. An entity is an eligible partnership if all of the
following conditions are met as of the test date:

(a) The entity is a partnership for federal tax purposes;

(b) All allocations of income, gain, loss, deduction, and credit of the
partnership have substantial economic effect; and

(c) At least 95 percent of the partnership's income for the test period
was (or is reasonably expected to be) income that is exempt from tax under
section 103.

(i) If, on the test date, the partnership has been in existence for at
least 6 full calendar months, then the test period is the 6 full calendar
months preceding the test date; and

(ii) If, on the test date, the partnership has not been in existence
for at least 6 full calendar months, then the test period is the first 6
full calendar months of the partnership's existence.


(2) TEST DATE. The test date is the first day of the month for which
the Monthly Closing Election is effective.


.02 ELIGIBLE PARTNER. A partner is an eligible partner if it is a RIC,
as defined in section 851, that is entitled to hold itself out as a money
market fund, or the equivalent of a money market fund, in accordance with
the provisions of Rule 2a-7(b).


SECTION 4. MONTHLY CLOSING ELECTION AND CONSENT

.01 EFFECT OF ELECTION AND CONSENT. If, at the end of any calendar
month, an eligible partnership has a Monthly Closing Election in effect
and one or more eligible partners of the partnership has a Monthly Closing
Consent in effect, then, with respect to each such partner, the
partnership must close its books as described in section 1.706-1(c)(2) of
the Income Tax Regulations as if the partner had sold its entire interest
in the partnership on the last day of that month. The partner must include
in its taxable income for that month the partner's distributive share of
items described in section 702(a) earned by the partnership since the last
closing of the books with respect to that partner and any guaranteed
payments under section 707(c) to the partner that are deductible by the
partnership since the last closing of the books with respect to that
partner. If the partner is on a 52-53 week taxable year, then the
provisions of section 1.441-2T(e) apply as if the last day of the month
was the last day of the partnership's taxable year.

.02 REPORTING REQUIREMENTS. In connection with this monthly closing of
the books, the partnership must provide each consenting eligible partner
information with respect to the partner's distributive share of items
described in section 702(a) and any guaranteed payments under section
707(c). To satisfy this requirement, the partnership may use a Schedule
K-1 (Form 1065), Partner's Share of Income, Credits, Deductions, etc., or
any other document or electronic communication that provides substantially
equivalent information (monthly statements). The partnership and each
consenting eligible partner must maintain the monthly statements but
should not file them with the Service. At the end of its taxable year the
partnership must provide a single Schedule K-1 (Form 1065) to each of its
partners (both the consenting and the nonconsenting partners). In the case
of a consenting eligible partner, this single annual Schedule K-1 must
include all amounts shown on the monthly statements issued to the partner.


SECTION 5. MONTHLY CLOSING ELECTION

.01 MANNER OF PARTNERSHIP MAKING THE ELECTION. An eligible partnership
may make a Monthly Closing Election by filing a statement with the
appropriate service center. The statement must be titled "ELECTION UNDER
REVENUE PROCEDURE 2002-16," and must include:

(1) Identification of the partnership by name, address, and EIN, and
the name and phone number of a contact person for the partnership;

(2) A statement that the partnership elects a monthly closing of the
books for all present and future consenting eligible partners;

(3) The signature of a person with authority to sign the partnership's
Form 1065, U.S. Return of Partnership Income; and

(4) The effective month of the election. The election is effective for
the calendar month in which the election is filed, unless the partnership
requests the election to be effective for either of the two immediately
preceding calendar months. For example, if a calendar year partnership
states that the monthly closing system is to begin for June, the
partnership will close its books June 30. Consenting eligible partners
must include their shares of partnership items and guaranteed payments for
the period from the last closing of the books (generally December 31 of
the prior year) through June 30. There will be a closing of the books and
a monthly inclusion of the partner's share of these items and guaranteed
payments at the end of each future month.


.02 TIME FOR MAKING THE ELECTION. The partnership's Monthly Closing
Election may be made at any time. See, however, section 6.03 of this
revenue procedure for limitations on the time for a partner to effect a
Monthly Closing Consent.


SECTION 6. MONTHLY CLOSING CONSENT

.01 MANNER OF PARTNER EFFECTING THE CONSENT.

(1) An eligible partner effects a Monthly Closing Consent by providing
a statement of consent to the custodian or manager of the partnership. The
statement of consent should also be attached to the partner's Form
1120RIC, U.S. Income Tax Return for Regulated Investment Companies, for
the first taxable year in which the consent is effective. Failure to
attach the partner's statement of consent to the partner's Form 1120RIC
does not invalidate the partner's consent, however.

(2) The statement of consent must be titled "STATEMENT OF CONSENT TO
ELECTION UNDER REVENUE PROCEDURE 2002-16" and must include:

(a) Identification of both the consenting partner and the partnership
by name, address, and EIN, and the name and phone number of a contact
person for each;

(b) A statement that the partner consents to the partnership's election
to a monthly closing of the books and that the partner will include in its
taxable income its distributive share of partnership items described in
section 702(a) and any guaranteed payments under section 707(c) in a
manner that is consistent with the election;

(c) The signature of an officer of the partner who is authorized to act
on behalf of the partner; and

(d) The effective month of the consent. The consent is effective for
the calendar month in which the partner acquires the partnership interest,
unless the partner requests that the consent be effective for either of
the two immediately following calendar months.


.02 ADDITIONAL REQUIREMENTS FOR MAKING A VALID MONTHLY CLOSING CONSENT.
An eligible partner does not qualify for the treatment described in
section 4 of this revenue procedure unless:

(1) The partner provides the statement of consent described in section
6.01 of this revenue procedure to the custodian or manager of the
partnership no later than the last day of the second calendar month after
the calendar month in which the partner acquires the partnership interest;
and

(2) The partnership's Monthly Closing Election is effective no later
than the second calendar month after the calendar month in which the
partner acquires the partnership interest.


SECTION 7. TERMINATION OF MONTHLY CLOSING ELECTION OR MONTHLY CLOSING
CONSENT

.01 A Monthly Closing Election or Monthly Closing Consent may be
revoked only with the consent of the Commissioner.

.02 Each month after the first calendar quarter in which a
partnership's Monthly Closing Election is effective, the definition of
eligible partnership in section 3.01 of this revenue procedure is
reapplied to the partnership, using the last day of the month as the test
date and that month and the preceding 2 months as the test period. If for
any month the partnership fails to satisfy the test mandated by the
preceding sentence, then the partnership's Monthly Closing Election is
terminated as of first day of the month. Even if the partnership
subsequently qualifies as an eligible partnership, it may not make another
Monthly Closing Election without the Commissioner's consent.

.03 If a consenting partner's status as an eligible partner (as defined
in section 3.02 of this revenue procedure) changes at any time, the
partner's Monthly Closing Consent is ineffective on any day when that
definition is not satisfied and is effective on any day when it is.
Therefore, no new Monthly Closing Consent is required when a consenting
partner sells one interest in an electing partnership and acquires another
interest in the same partnership at a time when the partnership continues
to have its Monthly Closing Election in effect.


SECTION 8. TRANSITION RULES FOR SOME ELECTIONS AND CONSENTS THAT ARE
REQUESTED TO BECOME EFFECTIVE DURING 2002

.01 CERTAIN MONTHLY CLOSING ELECTIONS FILED DURING 2002. If, using
March 1, 2002, as the test date, a partnership is an eligible partnership,
or is an existing but ineligible partnership, and, at any time during
2002, the partnership files the statement described in section 5.01 of
this revenue procedure, then, in addition to the permissible effective
dates described in section 5.01(4) of this revenue procedure, the
partnership may request that the Monthly Closing Election become effective
for any month in 2002 in which the partnership is an eligible partnership.

.02 CERTAIN MONTHLY CLOSING CONSENTS PROVIDED TO AN ELIGIBLE
PARTNERSHIP DURING 2002. In the case of any eligible partnership that is
described in section 8.01 of this revenue procedure and that files its
Monthly Closing Election during 2002, any RIC that is an eligible partner
of that partnership at any time during 2002 may effect a Monthly Closing
Consent by either:

(1) Complying with the procedures set forth in section 6 of this
revenue procedure; or

(2) Satisfying section 6.01 of this revenue procedure at any time
during 2002. In this case, the consent is effective for the month in which
the partner provides the statement of consent to the custodian or manager
of the partnership, unless the partner requests that the consent be
effective for any other calendar month of 2002.


SECTION 9. EFFECTIVE DATE

This revenue procedure is effective on January 1, 2002. However, for
the period prior to January 1, 2003, the Service will not challenge a
money market fund's monthly inclusion of its distributive share of
partnership items described in section 702(a) and guaranteed payments
described in section 707(c) in a manner similar to that described in
section 4 of this revenue procedure, provided that, had this revenue
procedure been in effect at the time of the inclusion, (1) the partnership
to which the items and payments are attributable would have been an
eligible partnership, and (2) the partner would have been an eligible
partner.


SECTION 10. PAPERWORK REDUCTION ACT

The collection of information contained in this revenue procedure has
been reviewed and approved by the Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control
number 1545-1768. An agency may not conduct or sponsor, and a person is
not required to respond to, a collection of information unless the
collection of information displays a valid OMB control number.

The collection of information is in sections 4, 5, and 6 of this
revenue procedure. This information is required to inform the Service
which partners and partnerships are making the designated election and to
report income appropriately. The collection of information is required to
obtain a benefit. The likely respondents are businesses.

The estimated total annual reporting and recordkeeping burden is 12000
hours.

The estimated annual burden per respondent/recordkeeper is 12 hours.
The estimated number of respondents and recordkeepers is 1000.

The estimated annual frequency of responses (used for reporting
requirements only) is once.

Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally tax returns and tax
return information are confidential, as required by 26 U.S.C. 6103.


SECTION 11. DRAFTING INFORMATION

The principal author of this revenue procedure is David A. Shulman of
the Office of the Associate Chief Counsel (Passthroughs and Special
Industries). For further information regarding this revenue procedure,
contact David A. Shulman at 202-622-3080 (not a toll-free call).

<<END RULING>>

 

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