DISTRICT OF COLUMBIA PROPOSED REGULATIONS ON EFFECTIVE DATE OF TAX ON NON-DISTRICT OF COLUMBIA TAX-EXEMPT BONDS

October 17, 1991 TO: TAX MEMBERS NO. 44-91 UNIT INVESTMENT TRUST MEMBERS NO. 50-91 MONEY MARKET MEMBERS - ONE PER COMPLEX NO. 25-91 RE: DISTRICT OF COLUMBIA PROPOSED REGULATIONS ON EFFECTIVE DATE OF TAX ON NON-DISTRICT OF COLUMBIA TAX-EXEMPT BONDS __________________________________________________________ In 1983, the District of Columbia enacted legislation which provided that, for obligations acquired on or after January 1, 1992, interest earned with respect to obligations exempt from tax under section 103 of the Internal Revenue Code other than obligations of the District of Columbia would be taxable. No tax would be imposed on interest earned with respect to tax-exempt obligations acquired before January 1, 1992. It was left to regulations to apply the rule to regulated investment companies ("RICs") which pay exempt-interest dividends. The enclosed proposed regulations provide guidance for information reporting by payors of certain types of income to District residents. Although the proposed regulations ostensibly apply to all RICs, the District has indicated that it is aware of its lack of jurisdiction over most RICs which operate outside the District. However, the regulations also apply to securities brokers and financial institutions and any other person who manages or administers RICs. Many RICs may be managed by organizations which have securities brokerage affiliates in the District, which may subject the organization to the reporting requirements. The proposed regulations require each RIC to send to the District and its shareholders a Form 1099 or other report form containing (1) the name, address and taxpayer identification number of the payor and payee and (2) the character and total amount of payments including, if applicable, a breakdown of the taxable and nontaxable state and local interest income earned by an individual, trust or estate. See Prop. Reg. section 111.7. The proposed regulation also would require a RIC or RIC manager to report to shareholders all portfolio transactions involving state and local obligations, including date of sale and sales proceeds for each transaction. See Prop. Reg. section 111.8(a). - 2 - This last requirement obviously should be inapplicable to RICs, as a RIC shareholder has no interest in underlying portfolio transactions. RICs which pay exempt-interest dividends are allowed to report information based upon an allocation of income between RIC shares purchased prior to January 1, 1992 and those acquired after December 31, 1991. The method set forth in Prop. Reg. section 111.9 is as follows: (1) The total income earned by the shareholder in the tax year, excluding capital gain income and nontaxable income such as that derived with respect to obligations of the District and obligations whose interest is exempt from District tax under federal law, such as obligations of Guam, Puerto Rico and the U.S. Virgin Islands, is divided by the total number of shares owned during the year. The result is the per share earnings of the RIC attributable to state and local government interest. (2) The amount of nontaxable income is then calculated by multiplying per share income by the number of shares held by the taxpayer on December 31, 1991. (3) The amount of taxable income is the difference between the total income and the nontaxable income. However, the proposed regulation theoretically requires that the per share income be multiplied by the number of shares acquired after December 31, 1991, in order to calculate taxable income. A shareholder which is an individual, trust or estate also is permitted to report actual earnings from a RIC, rather than the amounts reported by the RIC, which would allow for more specific allocation of income depending on when the income is paid or when shares are sold. Examples of such calculations are provided in Prop. Reg. section 111.13. For reporting purposes, the proposed regulations provide that under both methods shares are considered disposed of under the first-in, first-out method, or any other method permitted under Internal Revenue Code section 1012. As a practical matter this makes reporting impossible, because the RIC would have no way of knowing which method a shareholder uses, and the regulations do not provide a single method which the RIC may use in calculating the number of shares considered acquired prior to January 1, 1991. There are other obvious technical problems with the proposed regulations. For example, the calculations are based on the total number of shares owned in a year. Where the shareholder has purchased and sold shares in a year, to add together all shares held in a year would result in double counting. Also, there are no provisions included which deal with shares held in street name accounts. - 3 - Comments on the proposed regulations are due no later than November 15, 1991. If you have any comments on the proposed regulations, please call the undersigned at (202) 955-3521. We will keep you informed of further developments. David J. Mangefrida Jr. Assistant Counsel - Tax Enclosure