The Massachusetts Department of Revenue (“DOR”) has issued a discussion draft of a Directive to give professionally managed funds (other than mutual funds) rules for determining “trader” versus “investor” status. The distinction can be important in Massachusetts, which denies a personal income tax deduction for some investment-related federally deductible items (e.g., investment interest) unless they are incurred in a trade or business.
The draft Directive offers a general test for trader status and some numerical tests expressed as safe harbors. The general test contains six factors, all of which must be satisfied for a trader fund; they include references to trade frequency, the existence of third-party investors, a demonstrated primary objective of achieving short-term income or profit, restrictions on any long-term buy-and-hold investment strategies, the absence of certain redemption restrictions, and the absence of disclosure or documentation inconsistent with trader status. Under the two proposed safe harbors, a fund would be treated as having a primary objective of achieving short-term income or profit if (i) the average holding period of the fund’s assets, based on average fair market value during the tax year, is 45 days or less for the tax year, or (ii) at least 80% of the fund’s assets, based on average fair market value during the tax year, have holding periods of 30 days or less.
The draft Directive would also permit a portion of a fund to be treated as a trader fund under an apportionment rule if the fund satisfies the other general-test requirements and if its shorter-term investments (holding period of one year or less) constitute a “sufficiently material” portion of its activities. Where apportionment is available, the DOR would accept as a reasonable apportionment of trader expenses the percentage determined by the ratio that the fund’s investments with holding periods of 45 days or less bear to the fund’s total investments. Other apportionment approaches may be possible.
The Directive also provides guidance concerning the Massachusetts personal income tax treatment of management fees in a fund-of-funds structure.
The DOR has requested comments on the draft Directive by June 20, 2011.