Short-term capital gain distributions from a RIC - accounting income or corpus?

• Author: Taylor, Rick J.
• Position: Regulated investment company

When an estate or trust owns shares of a regulated investment company (RIC), the question often arises as to whether short-term capital gain distributions received from the RIC should be allocated to the estate's or trust's accounting income or corpus; that is, should the distributions be treated as ordinary income or capital gain? An answer to this question can be reached by analyzing Secs. 852 and 643 and the Revised Uniform Principal and Income Act (RUPIA).

Sec. 852(b)(2) generally defines taxable income of a RIC as all taxable income minus net capital gain. The term "net capital gain" is defined under Sec. 1222(11) as net long-term capital gain in excess of net short-term capital loss for the tax year. Thus, a RIC's taxable income equals all income other than long-term capital gain.

As a result, if a RIC has a net short-term capital gain, such gain will be included in computing to RIC's taxable income a taxed at ordinary income rates. Distributions to RIC shareholders out of short-term capital gains are treated as dividend income by the shareholders and not as short-term capital gains. Thus, under Sec. 852, conduit treatment is not available for short-term capital gains distributed from a RIC.

Sec. 643(b) provides that "the term `income', when not preceded by the words `taxable', `distributable net', or `gross', means the amount of income of the estate or trust for the taxable year determined under the terms of the governing instrument and applicable local law." Thus, the definition of accounting income is not contingent on any definition in the Internal Revenue Code of taxable income. Rather, an estate's or trust's accounting income must be determined under the governing instrument and applicable local law.

In the absence of specific provisions in the governing instrument, local law determines how short-term capital gains are treated. RUPIA Section 6...