July 27, 1994
TO: MONEY MARKET FUNDS AD HOC COMMITTEE NO. 16-94
MONEY MARKET MEMBERS - ONE PER COMPLEX NO. 8-94
RE: TREATMENT OF CERTAIN TAX-EXEMPT NOTES UNDER IRS RULES
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The Institute has learned that an issue has arisen concerning
the treatment under the Internal Revenue Code of tax-exempt notes
originally sold at a premium and issued with a final maturity in
excess of 12 months that do not pay interest at least annually.
Specifically, it has come to our attention that these notes may be
subject to the IRS' original issue discount rules, which makes it
more likely that they will have market discount for tax purposes
when sold in the secondary market. As a result, a buyer of these
notes in the secondary market may have taxable ordinary income.
Consequently, we have learned that there has been a decrease in
their market liquidity.
The IRS yesterday issued a Notice (94-84) to clarify the
proper tax treatment of tax-exempt notes with original maturities
of one-year or less. The Notice states that until further guidance
is issued, taxpayers may treat interest that is payable at maturity
either as included in the note's stated redemption price or as
"qualified stated interest." Taxpayers must, however, be
consistent in their treatment of such interest. The IRS Notice
does not apply to notes issued with final maturities in excess of
12 months.
Amy B.R. Lancellotta
Associate Counsel
Peter J. Cinquegrani
Assistant Counsel - Tax