A critical piece of the SEC's money market reform rules is a proposal by the U.S. Department Treasury and IRS to allow floating NAV money market fund investors to use a simplified tax accounting method to track gains and losses and provide relief from the "wash sale" rules for any losses on shares of a floating NAV money market fund. In a July 23rd release ("Treasury Guidance on Accounting for Gains and Losses in Certain Money Market Funds") that coincided with the SEC's vote to adopt money fund reform, the Treasury Department wrote, "Today's guidance is proposed rather than final to provide the public an opportunity for comment. Nevertheless, shareholders in floating NAV MMFs can now rely on these proposed regulations to begin to use the simplified method."

The Treasury/IRS proposal sealed the deal for the passage of money market reform as SEC Commissioner Daniel Gallagher, who turned out to be the swing vote, said he would not have voted in favor without this assurance from the Treasury and IRS. "I have consistently, loudly, and publicly stated that my vote for a floating NAV was contingent on the resolution of the tax and accounting-related issues arising from the move away from a constant NAV. As we make abundantly clear in today's release, the accounting issues have been completely addressed: money funds are cash equivalents," stated Gallagher.

We excerpt portions of the Treasury's proposal below. It explains, "This document contains proposed regulations that provide a simplified method of accounting for gains and losses on shares in money market funds (MMFs) that distribute, redeem, and repurchase their shares at prices that reflect market-based valuation of the MMFs' portfolios and more precise rounding than has been required previously (floating net asset value MMFs, or floating-NAV MMFs). The proposed regulations also provide guidance regarding information reporting requirements for shares in MMFs. The proposed regulations respond to Securities and Exchange Commission (SEC) rules that change how certain MMF shares are priced. The proposed regulations affect floating-NAV MMFs and their shareholders."

It continues, "Until the SEC MMF Reform Rules change how certain MMFs price their shares, Rule 2a–7 permits any MMF meeting the other requirements of Rule 2a–7 to compute its price per share for purposes of distribution, redemption, and repurchase by using either or both of (a) the amortized cost method of valuation, and (b) the penny-rounding method of pricing. Under the amortized cost method, an MMF's NAV is determined by valuing the fund's portfolio securities at their acquisition cost, adjusted for amortization of premium or accretion of discount. Under the penny-rounding method, an MMF's NAV is rounded to the nearest one percent in computing the price per share for purposes of distribution, redemption, and repurchase. These methods have enabled MMFs to maintain constant share prices except in situations in which the "deviation [of the current net asset value per share calculated using available market quotations] from the money market fund's amortized cost price per share exceeds 1/2 of 1 percent" (commonly called "breaking the buck")."

Treasury writes, "The SEC MMF Reform Rules generally bar the use of the amortized cost method of valuation and the use of the penny-rounding method of pricing, except by government MMFs and retail MMFs.... An MMF that uses market factors to value its securities and uses basis point rounding to price its shares for purposes of distribution, redemption, and repurchase has a share price that is expected to change regularly, or "float." (This fact explains the origin of the term "floating-NAV MMF".) Floating-NAV MMFs therefore resemble in some respects other mutual funds that are not MMFs, but they remain subject to the risk-limiting conditions in Rule 2a–7 and are expected to continue to fulfill MMFs' unique role. In the absence of the simplified method of accounting proposed in this document, current law would require shareholders to compute gain or loss on every redemption of shares in a floating-NAV MMF."

The proposal also states, "In response to concerns regarding the tax compliance burdens associated with frequent redemptions of shares in floating-NAV MMFs, these proposed regulations describe a permissible, simplified method of accounting for gain or loss on shares in a floating-NAV MMF (the net asset value method, or NAV method). The NAV method, in the opinion of the Commissioner of Internal Revenue, is a method of accounting that clearly reflects income from gain or loss on shares in floating-NAV MMFs. Under this method, gain or loss is based on the change in the aggregate value of the shares in the floating-NAV MMF during a computation period (which may be the taxpayer's taxable year or certain shorter periods) and the net amount of the purchases and redemptions during the period. More specifically, the taxpayer's net gain or loss from shares in a floating-NAV MMF for a computation period generally equals the value of the taxpayer's shares in the MMF at the end of the period, minus the value of the taxpayer's shares in the MMF at the end of the prior period, minus the taxpayer's net investment in the MMF during the period. The NAV method does not change the tax treatment of, or broker reporting requirements for, dividends from floating-NAV MMFs. The proposed method simplifies tax computations by basing them on the aggregate of all transactions in a period and on aggregate fair market values. Every floating-NAV MMF must compute these fair market values for non-tax purposes regardless of how -- or even whether -- the MMF's shareholders are taxed on transactions in the MMF shares. The NAV method takes into account changes in value of floating-NAV MMF shares without regard to realization."

It goes on to say, "Section 1.6045-1(c)(3)(vi) provides an exception to the broker reporting requirement under section 6045 for shares in an MMF "that computes its current price per share for purposes of distributions, redemptions, and purchases so as to stabilize the price per share at a constant amount that approximates its issue price or the price at which it was originally sold to the public...." Comments received by the SEC in response to the SEC MMF Reform Proposal expressed concern that the existing exception would not apply to floating-NAV MMFs and suggested that requiring transaction-by-transaction information reporting would impose significant new costs on floating-NAV MMFs and intermediaries. The Treasury Department and the IRS believe that imposing broker reporting requirements on floating-NAV MMFs would result in administrative burdens that are not justified in light of the expected relative stability of floating-NAV MMF share prices. Therefore, the proposed regulations revise Section 1.6045-1(c)(3)(vi) to clarify that the exceptions under sections 6045, 6045A, and 6045B continue to apply to all MMFs, including floating-NAV MMFs."

On "wash-sale" rules it explains, "A shareholder of a floating-NAV MMF that does not use the NAV method, however, may experience frequent wash sales. For a shareholder with a substantial volume of transactions in floating-NAV MMF shares, tracking wash sales of MMF shares could present significant practical challenges. On July 29, 2013, the IRS published Notice 2013-48 (2013-31 IRB 120) in response to the SEC MMF Reform Proposal. The notice proposed a revenue procedure providing that the IRS would not treat a loss realized upon a redemption of a floating-NAV MMF share as subject to the wash sale rules if the amount of the loss was not more than one half of one percent of the taxpayer's basis in that share. The IRS received comments indicating that the proposed revenue procedure would not significantly reduce the tax compliance burdens associated with applying the wash sale rules to floating-NAV MMFs because shareholders would still have to track all wash sales to determine whether the amount of any particular wash sale exceeds the 0.5% de minimis test. The comments requested that floating-NAV MMFs be exempted entirely from the wash sale rules in section 1091. Concurrently with these proposed regulations, the Treasury Department and the IRS are releasing a final revenue procedure providing that the wash sale rules will not be applied to redemptions of shares in floating-NAV MMFs. This revenue procedure will apply to redemptions of shares in floating-NAV MMFs on or after the effective date of the SEC MMF Reform Rules (expected to be 60 days after their publication in the Federal Register)."

Further, "These regulations concerning the NAV method are proposed to apply to taxable years ending on or after the date of publication in the Federal Register of a Treasury decision adopting these proposed regulations as final regulations. Shareholders of floating-NAV MMFs, however, may rely on the rules in the regulations concerning the NAV method for taxable years ending on or after [date of this document in the Federal Register] and beginning before the date of publication in the Federal Register of a Treasury decision adopting these proposed regulations as final regulations."

Comments on the Treasury's proposal may be mailed to the Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044, hand-delivered to the IRS, or sent electronically via the Federal eRulemaking portal at www.regulations.gov. A public hearing has also been scheduled for November 19 at 10:00 a.m. at the IRS Building in Washington.

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