Regulated Investment Companies (RICs) are taxed as corporations, where the entity-level corporate income tax is typically eliminated by applying the dividends paid deduction (DPD) allowed via Internal Revenue Code (IRC) Section 561.
At a basic level, as long as a RIC distributes to shareholders substantially all of its investment company taxable income and exempt-interest income for its taxable year (computed prior to the DPD), and complies with other IRC requirements, the RIC is allowed a DPD to reduce its investment company taxable income and net capital gain to zero. Further, a RIC has the full 12-month period after the close of the tax year to make the dividend payments that count towards the DPD, subject to certain payment and declaration requirements specified by IRC Section 855.
Although a relatively rare occurrence, what if a RIC finds itself in need of additional DPD and the 12-month period following the close of the RIC’s tax year has expired? Will a RIC have no choice but to pay corporate-level tax along with potential late payment and other penalties, and, in more severe instances, risk losing its tax status as a RIC?
IRC Section 860 specifies the circumstances for which a RIC can qualify and pay a "deficiency dividend" to remedy this situation, if a determination results in an adjustment to taxable income for that year. A determination includes, but is not limited to:
An adjustment refers to an increase in investment company taxable income or net capital gain for the taxable year to which the adjustment relates, or a decrease to the DPD for that year.
For administrative purposes, a RIC must pay the deficiency dividend to shareholders within 90 days, and file Form 976 with all required attachments to claim a deduction for the dividend payment within 120 days of the date of determination. The statute of limitations for assessment of taxes and penalties is suspended for two years following the filing of Form 976. Additionally, in cases where the source of determination is an amendment on the part of the taxpayer, the RIC (or a Real Estate Investment Trust, to which the deficiency dividend procedures also apply) must also first make the self-assessed determination by filing Form 8927 with the IRS under procedures outlined in Rev. Proc. 2009-28.
IRC Section 860(c) provides guidance on how interest is to be calculated for a deficiency dividend. The increase in tax related to the deficiency dividend is deemed to be an addition to the original taxes imposed on the RIC and is considered paid as of the date Form 976 is filed. Thus, the interest charge is calculated pursuant to IRC Sections 6601(b) and 6621 from the date the original tax return was due (without regard to extensions) to the date that Form 976 is filed.
If a RIC determines that an increase in investment company taxable income is required more than 12 months following the close of the RIC’s tax year, management should promptly consult its tax advisors. If the payment of a deficiency dividend is the best course of action, the determination, payment and filing of Form 976 should be completed as soon as possible to claim the additional DPD and minimize potential interest charges.
Contact Jay Laurila at or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.