Tuesday, September 23, 2008

IRS Notice 2008-81 Says Treasury Program to Support Money Market Funds Does Not Run Afoul of Federal Guarantee of Tax Exempt Bonds under IRC

The IRS has found that the Treasury program to support tax-exempt money market funds during this period of market turmoil does not violate restrictions against federal guarantees of tax-exempt bonds under Section 149(b) of the Internal Revenue Code. All money market mutual funds that are regulated under Rule 2a-7 of the Investment Company Act and are publicly offered and registered with the SEC are eligible to participate in the program. But the IRS guidance applies specifically to tax-exempt money market funds.

The Treasury Department has offered temporary, unlimited deposit insurance for money market funds. The support program is available to both money market funds holding assets subject to federal income taxation and to tax-exempt money market funds. In Notice 2008-81, the IRS said that the program will not result in any violation of the restrictions against federal guarantees of tax-exempt bonds with respect to the tax-exempt bond assets of tax-exempt money market funds which would impair the tax-exempt status of dividends received by their shareholders.

Section 103 of the Code provides that the interest on state and local government bonds is excludable from gross income, except that under Section 149(b) the interest is not excludable if the bonds are federally guaranteed.

The notice provides comfort that the IRS will not assert that the Treasury’s support program for money market funds causes any violation of the restrictions against federal guarantees of tax-exempt bonds under Section 149(b) with regard to any tax-exempt bond assets held by participating tax exempt money market funds. Similarly, the IRS will not assert that the program impairs the ability either of a participating money market fund to designate exempt interest dividends under § 852(b)(5) or of the shareholders of such a fund to claim the benefits of tax exemption with respect to such exempt interest dividends under § 852(b)(5)(B).