1 See Institute Memorandum to Tax Members No. 27-97, Accounting/Treasurers Members No. 31-97, Operations
Members No. 13-97, International Members No. 12-97, Closed-End Investment Company Members No. 23-97, Unit
Investment Trust Members No. 28-97 and Transfer Agent Advisory Committee No. 36-97, dated August 1, 1997.
[10077]
June 26, 1998
TO: TAX MEMBERS No. 18-98
ACCOUNTING/TREASURERS MEMBERS No. 16-98
OPERATIONS MEMBERS No. 17-98
CLOSED-END INVESTMENT COMPANY MEMBERS No. 19-98
UNIT INVESTMENT TRUST MEMBERS No. 14-98
INTERNATIONAL MEMBERS No. 13-98
TRANSFER AGENT ADVISORY COMMITTEE No. 33-98
BROKER/DEALER ADVISORY COMMITTEE No. 10-98
RE: CONFERENCE AGREEMENT ON IRS RESTRUCTURING BILL
______________________________________________________________________________
The Conference Committee this week resolved all differences between the House and
Senate versions of the Internal Revenue Service Restructuring and Reform Act of 1998 ("the
1998 Act") and reported it for final approval. On June 25, the House approved the bill by a vote
of 402 to 8. The Senate is expected to approve the 1998 Act upon returning from the Fourth of
July recess. President Clinton has indicated that he will sign this legislation into law.
The 1998 Act contains several tax provisions of interest to regulated investment
companies ("RICs") and their shareholders. Included in the 1998 Act are a reduction in the
holding period requirement (from 18 months to 12 months) for 20 percent rate gain treatment,
technical corrections to the Taxpayer Relief Act of 1997 ("the 1997 Act"),1 IRS Appeals Office
review of IRS agent determinations that municipal bonds should be treated as taxable, tax
information reporting changes and the creation of an accountant/client tax advice privilege.
2 The attachments include the statutory language and, where sufficiently detailed to be helpful, the Statement of
Managers’ explanation.
3 The 1997 Act provides that taxpayers in the 15 percent rate bracket are taxed on these gains at a 10 percent rate.
4 The 20 percent maximum rate also applied, as originally enacted, to assets held for more than 12 months that were
sold after May 6, 1997 and before July 29, 1997.
5 Beginning in 1999, RIC capital gain dividends generally will be taxable at only one maximum rate, i.e., 20 percent.
Some RICs, however, may have other types of long-term gains not affected by the 1998 Act, including "collectibles
gain" that remains taxable at a 28 percent maximum rate and "unrecaptured section 1250 gain" that remains taxable at
a 25 percent maximum rate.
6 See Institute Memorandum to Tax Members No. 37-97, Accounting/Treasurers Members No. 40-97, Operations
Members No. 22-97, Closed-End Investment Company Members No. 29-97, Unit Investment Trust Members No. 40-
97 and Transfer Agent Advisory Committee No. 56-97, dated October 10, 1997.
7 See Institute Memorandum to Tax Members No. 41-97, Accounting/Treasurers Members No. 44-97, Operations
Members No. 25-97, Closed-End Investment Company Members No. 33-97, Unit Investment Trust Members No. 46-
97, Transfer Agent Advisory Committee No. 61-97 and Broker/Dealer Advisory Committee No. 17-97, dated October
28, 1997.
12-Month Holding Period Requirement for 20-Percent Rate Gain Treatment (Attachment A)2
The 1997 Act created a multiple-tier capital gains rate structure by reducing from 28
percent to 20 percent3 the maximum tax rate for gains on certain assets, including those sold
after July 28, 1997 that were held for more than 18 months.4 One effect of this multiple-tier
structure was that capital gain dividends paid by a RIC to its shareholders during 1997
typically were taxable in part at a 28 percent maximum rate (e.g., for certain gains on assets
held for more than 12 months but not more than 18 months) and in part at a 20 percent
maximum rate (e.g., for certain gains on assets held for more than 18 months).
The 1998 Act eliminates the 18-month holding period requirement for property sold
after December 31, 1997. Thus, any gain on the disposition after 1997 of RIC shares held for
more than 12 months will be taxed at a 20 percent maximum rate. However, if any portion of
any RIC capital gain dividend paid during 1998 is attributable to any gain on assets sold during
1997 that is taxed, under the 1997 Act, at a 28 percent maximum rate, this portion of the 1998
dividend apparently will remain taxable at a 28 percent maximum rate.5
Technical Corrections
The 1998 Act includes technical corrections to the 1997 Act, including significant
revisions to the capital gains rules and two technical corrections, urged by the Institute, relating
to RIC investments in passive foreign investment companies ("PFICs") and application to RICs
of the new holding period requirements for claiming foreign tax credits.
Capital Gains (Attachment B)
First, the 1998 Act enacts the capital gains technical corrections that were considered last
fall by the House of Representatives6 and taken into account by IRS in administering the tax
laws during 1997.7 These technical corrections include changes to the methodology for netting
gains and losses from different categories and a provision treating all transactions the gain on
8Since 1992 (following the release of IRS Notice 92-53, which permitted reliance for one year on proposed mark-to-
market regulations, and informal administrative assurances that the regulations would be effective, when finalized,
retroactive to the expiration of the Notice), RICs have marked their PFIC shares to market and included in income
any excess of the fair market value of the stock over its adjusted basis. This treatment was necessary to avoid an
unintended RIC-level tax that could not be eliminated by distributing to the RIC’s shareholders the income arising
from these investments. See, e.g., Institute Memorandum to Tax Members No. 73-92, Accounting/Treasurers
Members No. 41-92, Closed-End Fund Members No. 45-92 and International Members No. 25-92, dated November 9,
1992.
9 Any tax that cannot be credited because of the new holding period requirement remains deductible.
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which would be taxable at a 28 percent maximum rate as within one category called "28 percent
rate gain."
PFIC Unreversed Inclusions (Attachment C)
The 1998 Act also resolves a problem arising from the unique circumstances pursuant to
which RICs were marking to market their PFIC shares (pursuant to formal and informal
administrative guidance from IRS and Treasury) before legislation permitting mark-to-market
treatment was enacted in 1997.8 Specifically, the 1997 Act permitted taxpayers such as RICs
both to elect to mark to market each year their PFIC shares and, in certain cases, to take an
ordinary deduction for (a) any excess of the adjusted basis of the PFIC shares over the fair
market value of the shares as of the close of the taxable year, and (b) a loss on the disposition of
the PFIC shares. The ability to take an ordinary deduction was limited to the amount of any net
mark-to-market gains with respect to the PFIC shares that the taxpayer included in income
pursuant to the 1997 Act (an amount known as the "unreversed inclusion").
As recommended by the Institute, the 1998 Act permits a RIC to include it its calculation
of unreversed inclusions all amounts that it has treated as PFIC mark-to-market income,
whether pursuant to the administrative guidance or the statute. This technical correction
applies as if it were enacted as part of the 1997 Act (i.e., to taxable years of U.S. persons
beginning after December 31, 1997, and taxable years of foreign corporations ending with or
within such taxable years of U.S. persons).
Foreign Tax Credit Holding Period Requirement (Attachment D)
Another technical correction recommended by the Institute resolves an unintended
complexity created as part of the 1997 Act’s modification of the rules for claiming foreign tax
credits. In addition to simplifying the reporting requirements applicable to individuals
claiming foreign tax credits of less than $300 ($600 on a joint return), the 1997 Act provided that
no credit for foreign taxes may be claimed by a taxpayer unless the stock is held by the taxpayer
for at least 16 days around the record date for the dividend. In the case of foreign taxes paid by
RICs (which may be "flowed through" pursuant to section 853 to the RIC’s shareholders), the
16-day holding period requirement must be met both at the RIC level, with respect to the
foreign stock’s dividend, and at the RIC shareholder level, with respect to the RIC shares’
dividend.9
10 See Institute Memorandum to Tax Committee No. 22-98 and Unit Investment Trust Committee No. 19-98, dated
June 17, 1998.
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The problem for RIC shareholders arising from the 1997 Act’s new 16-day holding
period requirement is that the 1997 Act did not make a corresponding change to the rules under
section 853 which provide that a RIC electing flow-through treatment effectively must gross up
its dividends by all foreign taxes that it pays. Thus, a RIC electing section 853 treatment
effectively would be required by the 1997 Act to gross up its dividend for all foreign taxes,
including those for which the credit is denied by the new holding period requirement. The
RIC’s shareholders also must be advised of the portion of the grossed-up amount that must be
deducted, rather than credited, because of the new holding period requirement.
Adopting the Institute’s suggestion, the 1998 Act provides that RICs electing flow-
through treatment may deduct any tax that, because the RIC failed to meet the 16-day holding
period requirement, cannot be claimed as a credit at the RIC shareholder level. Under this
approach, the RIC shareholders’ dividends would be grossed up only by foreign taxes for
which they can claim credit. This technical correction applies as if it were enacted as part of the
1997 Act (i.e., with respect to any dividend paid or accrued more than 30 days after enactment
of the 1997 Act (which occurred on August 5, 1997)).
IRS Appeals Office Review of Adverse Determinations of Tax-Exempt Bond Status
(Attachment E)
The 1998 Act also provides issuers of municipal bonds with a new right when IRS
examiners determine that a previously-issued municipal bond is taxable. Specifically, the 1998
Act instructs IRS to amend its administrative procedures to provide that issuers in such a case
"shall have an administrative appeal of right to a senior officer of the Internal Revenue Service
Office of Appeals." This directive to IRS is effective on the date of enactment.
While the Conference Agreement does not include the Senate provision that would have
provided issuers with the right to file a declaratory judgment action in the U.S. Tax Court to
determine the tax-exempt status of the previously-issued bonds,10 the issue is discussed in the
Statement of Managers accompanying the Act. In particular, the Statement of Managers
provides that the conferees intend for Congress to evaluate judicial remedies in future
legislation once the IRS’ tax-exempt bond examination program has developed more fully and
the Congress is better able to ensure that any future measure protects all parties with an interest
in these determinations (including issuers, bondholders and the Federal Government).
Due Dates for Providing Year-End Tax Information (Attachment F)
The 1998 Act provides that any information return the filing of which is required under
sections 6041 through 6053 -- including Forms 1099-DIV (dividend income) and 1099-B (gross
proceeds) -- will be treated as filed timely with IRS if filed electronically by March 31 (rather
than the present-law due date of February 28). This change to the information reporting due
date applies to returns required to be filed after December 31, 1999.
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In addition, the 1998 Act requires the Secretary of the Treasury to conduct a study, to be
completed no later than June 30, 1999, evaluating the effect of extending from January 31 to
February 15 the deadline for providing Forms 1099-DIV and 1099-B (among others) to payees,
including RIC shareholders.
Electronic Filing (Attachment G)
Other provisions of the 1998 Act, generally effective on the date of enactment, that are
intended to encourage electronic filing would:
require IRS to develop procedures for the acceptance of signatures in digital or
other electronic form;
permit IRS to provide alternative methods of signing returns, declarations,
statements and other documents;
treat for all purposes (including penalties of perjury declarations) any document
signed under one of these alternative methods in the same manner as though
actually signed; and
require IRS to establish procedures, in the case of taxable periods beginning after
1998, for all tax forms, instructions and publications created for the most recent
5-year period to be made available electronically on the Internet in a searchable
database at approximately the same time such records are available to the public
in paper form.
Accountant/Client Tax Advice Privilege (Attachment H)
The 1998 Act generally extends the attorney/client privilege to "tax advice" provided by
certified public accountants and other "federally authorized tax practitioners." The privilege
may be asserted only in noncriminal tax matters before the IRS and in Federal Court in
noncriminal tax proceedings where the United States is a party. Moreover, the privilege may
be waived in the same manner as the attorney-client privilege and cannot be asserted to
prevent disclosure of information to any regulatory body other than the IRS. This provision
applies to communications made on or after date of enactment.
Keith D. Lawson
Senior Counsel
Attachment
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Note: Not all recipients of this memo will receive an attachment. If you wish to obtain a copy
of the attachment referred to in this memo, please call the Institute’s Library Services Division
at (202)326-8304, and ask for this memo’s attachment number: 10077.