August 9, 1993
TO: BOARD OF GOVERNORS NO. 70-93
RE: CONGRESS APPROVES TAX BILL
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Friday evening, Congress gave final approval to the Omnibus Budget
Reconciliation Act of 1993 (H.R. 2264). Several of the Act's provisions are
of interest to regulated investment companies ("RICs") and their shareholders.
1. Provisions to Prevent Conversion of Ordinary Income to Capital Gain
A. Ordinary Income Treatment for All Market Discount
Of particular importance to tax-exempt bond funds, the Act treats any
market discount recognized on a tax-exempt bond as taxable ordinary income and
not capital gain, as was previously the rule. Ordinary income treatment is
also required for market discount on bonds issued on or before July 18, 1984;
taxable bonds issued after that date are already subject to ordinary income
treatment. These changes are effective for obligations purchased after April
30, 1993.
B. Recharacterization of Gain in "Conversion Transactions"
The Act converts gain on the sale or exchange of a capital asset that is
held as part of a "conversion transaction" to ordinary income. According to
the Conference Report, the taxpayer in a conversion transaction "is in the
economic position of a lender - he has an expectation of a return from the
transaction which in substance is in the nature of interest and he undertakes
no significant risks other than those typical of a lender." These new gain
recharacterization provisions apply to conversion transactions entered into
after April 30, 1993.
It appears that this legislation could have an impact on those funds
holding short-term debt instruments that have been promoted as vehicles for
converting ordinary income into capital gain. These funds typically minimize
their ordinary income distributions to shareholders by making maximum use of
the dividends paid deduction for amounts paid out on redemption, a practice
known as "tax equalization."
2. Targeted Capital Gains Exclusion
Under the Act, an individual investor who acquires stock at original
issue in a corporation with gross assets of $50 million or less (a "qualified
small business") and holds the stock for more than 5 years, either directly or
through a pass-through entity such as a RIC, is permitted (subject to certain
limitations) to exclude from income 50 percent of any gain realized upon the
disposition of the stock. In the case of a RIC investor, the qualified small
business stock must be (1) acquired by the RIC after the investor's RIC shares
are purchased and (2) disposed of more than 5 years after the stock is
acquired and while the RIC investor continues to hold his shares in the RIC.
3. Amortization of Intangibles
The Act also provides that the purchase price of certain acquired
intangible assets is to be amortized over a uniform 15-year period. The
Treasury Department is given authority to reduce this period for rights that
have a fixed duration of less than 15 years. Among the intangible assets
covered by the Act are goodwill, going concern value and various customer-
based intangibles, including investment management contracts. The provision
is generally effective for property acquired after the date of enactment,
although a taxpayer can elect to have the Act apply to all property acquired
after July 25, 1991.
4. Denial of Deduction for Lobbying Expenses
The Act disallows any deduction for amounts paid or incurred in
connection with (1) influencing Federal or State legislation or (2) any
communication with certain senior Fedral executive branch officials in an
attempt to influence the official actions or positions of such officials. The
Act defines "influencing legislation" as "any attempt to influence any
legislation through communication with any member or employee of a legislative
body, or with any government official or employee who may participate in the
formulation of legislation." Also disallowed as deductions are amounts "paid
or incurred for research for, or preparation, planning, or coordination of,
any lobbying activity."
The disallowance for non-legislative communications with certain senior
Federal executives is limited to direct communications with the President, the
Vice President, Cabinet-level officials and their deputies, the two most
senior-level officials of each agency within the Executive Office of the
President and the White House staff.
The deduction disallowance applies to the portion of membership
organization dues which is allocable to such lobbying and political
expenditures. A trade association is required to provide annual information
disclosure (but not on IRS Forms 1099) to members regarding lobbying
expenditures, unless the association elects to pay a proxy tax computed at the
top corporate tax rate (35 percent) on the amount of its lobbying expenditures
for the year. In addition, an association must disclose on its annual tax
return, whether or not it pays the proxy tax, the amount of its lobbying
expenditures.
These changes apply to amounts paid or incurred after December 31, 1993.
The Institute will provide information in the near future regarding the effect
of this provision on Institute dues.
5. Compensation Limits for Retirement Plans
Under the Act, the amount of compensation that can be taken into account
under retirement plans will be reduced to $150,000, effective for benefits
accruing in plan years beginning after December 31, 1993. The $150,000 limit
will be adjusted for inflation, but only in increments of $10,000.
* * *
A more detailed memorandum, with attachments, is being distributed to
Tax Members, Accounting/Treasurers Members and Pension Members. Please
contact Keith Lawson (202/955-3585) or Kathy Ireland (202/955-3516) for
additional information.
We will keep you informed of developments.
Matthew P. Fink
President