December 26, 1989
TO: TAX MEMBERS NO. 51-89
MONEY MARKET FUND CHIEF EXECUTIVE OFFICERS NO. 12-89
RE: PASS-THROUGH OF FEDERAL OBLIGATION INTEREST -
NORTH CAROLINA
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North Carolina has modified the manner and extent to which
it permits funds to pass through dividends attributable to
interest derived from federal obligations free of state tax.
Under prior law, pass-through treatment was available for the pro
rata portion of the fund dividend attributable to federal
obligation interest. Under the new North Carolina law,
shareholders reduce their state tax for such interest via a tax
credit.
Under the amended North Carolina statute, North Carolina
shareholders are entitled to a tax credit equal to six percent of
the amount of certain dividends received during the taxable year
from a "qualified corporation;" the maximum credit is $300 per
taxpayer per year. The $300 maximum credit provides an exclusion
from tax (at a six percent tax rate) for the first $5,000 of
dividends attributable to federal obligation interest. In the
case of a married couple where both spouses receive dividends,
the $300 maximum credit applies separately to each spouse's
dividends.
A regulated investment company ("RIC") is a "qualified
corporation" if fifty percent or more of its dividends would be
deductible, by reason of the state's dividends received
deduction, if paid during the taxable year to corporate
shareholders. Because a dividends received deduction is provided
by North Carolina law for RIC dividends attributable to income
which would not be taxed by North Carolina if received directly
by corporate shareholders, a RIC is a qualified corporation if
fifty percent or more of its dividend income is attributable to
interest on federal obligations and/or North Carolina
obligations.
The attached announcement by the North Carolina Department
of Revenue discusses these statutory changes. The announcement's
first example illustrates the operation of the tax credit for an
individual shareholder receiving both capital gain and ordinary
dividend distributions from a RIC investing in United States
Government bonds. As $1,500 of the RIC dividend is attributable
to federal obligation interest, the shareholder receives a
dividend tax credit of $90 ($1,500 x 6%).
The mechanism for pass-through treatment for North Carolina
state and local obligation interest is also addressed. In
essence, the pro rata portion of the dividend attributable to
North Carolina interest passes through so long as at least fifty
percent of the value of the fund's total assets, at the close of
each quarter, consists of state and local bonds. Example 2
illustrates these rules.
We will keep you informed of developments.
Keith D. Lawson
Assistant General Counsel
Attachment