Last week the IRS issued guidance on two subjects relating to money market funds:

  • the taxation of contributions by advisors to a money market fund, and
  • the diversification rules for insurance-dedicated money market funds.

Rev. Proc. 2016-31 focuses on contributions by advisors to money market funds arising from the SEC's money market reform rules. The guidance provides that if a money market fund receives a qualifying contribution from an advisor in connection with a conversion to a floating-NAV status, the fund will not be required to distribute that amount to stockholders. Note, however, that the fund must pay tax on the amount of the contribution. The guidance is important because without it, the advisor would generally have to gross-up the amount of such a contribution by over ten times the amount.

Notice 2016-32 focuses on the diversification requirements for insurance-dedicated money market funds. Under current practice, only a limited number of United States agencies or instrumentalities issue securities that SEC Rule 2a-7 allows a money market fund to hold. Due to the SEC's money market reform rule, many money funds are expected to become government funds, which means that there is about to be an increased demand for such government securities, which in turn means that a money market fund may have greater difficulty in acquiring the assets necessary to qualify both as a government fund and to satisfy the diversification requirements under Code Section 817(h).

The Notice states that the Treasury Department and the IRS intend to amend the Section 817 regulations to alleviate this problem. In the meantime, funds may rely on a new diversification test that generally provides that if the investment satisfies SEC Rule 2a-7(a)(14), it will satisfy the diversification requirements as well.