There is a new reality for dealing with floating rate money market shares. On July 8, 2016, the Department of the Treasury finalized regulations permitting the use of a new accounting method for investors in floating rate money market shares of registered investment companies.¹

Traditionally, money market funds (MMFs) have maintained a stable net asset value (NAV) of $1.00, although there have been instances in which MMFs have "broken the buck." The Securities and Exchange Commission’s (SEC’s) new rules regarding MMFs will cause many MMFs to utilize a floating NAV beginning in October 2016. Pursuant to the SEC’s rules, many MMFs will impose liquidity fees and/or redemption gates in certain circumstances. An MMF will temporarily suspend the redemption of MMF shares when a redemption gate is in effect and will reduce the amount received by redeeming shareholders when a liquidity fee is in effect. The final regulations also eliminate the need for MMFs to provide cost basis reporting to their investors.

The change to a floating rate NAV will complicate the use of MMFs as cash management accounts on which investors do not typically expect to have gains or losses. To address these changes, in 2014, the Treasury Department and the Internal Revenue Service (IRS) proposed regulations to deal with the tax issues presented by floating rate NAVs for MMFs. Those proposed regulations were changed in what can be viewed as taxpayer-friendly ways and finalized.

Adoption of the NAV Method

Under the final regulations, taxpayers may adopt a method of accounting, called the net asset value method (the NAV Method), for MMFs in order to simplify the accounting associated with floating NAV MMFs. The NAV Method will replace the need for computing gain and loss for each transaction in shares of the MMF. Additionally, in response to comments provided on the proposed regulations, taxpayers may utilize the NAV Method to account for stable NAV MMFs and for liquidity fees or on the rare occasion when stable NAV MMFs "break the buck."

Under the NAV Method, an investor in MMF shares can choose a computation period over which to compute the gain and loss for the MMF. A computation period may only include days from one taxable year. Pursuant to the NAV Method, an investor computes the aggregate gain or loss in MMF shares for the computation period by taking the aggregate fair market value at the end of the computation period less the aggregate basis for the MMF shares at the beginning of the computation period and the net investment in the MMF for the period. Net investment for the period equals the aggregate cost of MMF shares purchased during the computation period less the aggregate amount received during the computation period in redemption of MMF shares. The investor would then report the gain or loss for all computation periods in the relevant taxable year. For an investor holding the MMF shares as a capital asset, the gain or loss would be a short-term capital gain or loss. Thus, each transaction does not generate a gain or loss, but instead an aggregate gain or loss is computed. The investor would also have to include any taxable dividends received as ordinary income. Taxpayers can utilize the NAV Method on an account-by-account basis.

Pepper Perspective

The regulations provide a simplified method for accounting for gains and losses for floating or stable NAV MMF shares and provide detailed rules for specific situations that are generally taxpayer friendly. Although some commenters had asked for guidance on liquidity fees, that was not provided. Nevertheless, the rules generally give helpful and timely guidance for dealing with the new reality of floating rate MMFs. It is important to note that taxpayers subject to these rules need to review the election provisions to take advantage of this generally helpful guidance.

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