IRS Eases Liquidity Requirements for Publicly Offered RICs and REITs
To alleviate the cash needs of regulated investment companies (RICs) and real estate investment trusts (REITs) in the face of the economic effects of COVID-19, on May 4, 2020, the Internal Revenue Service (IRS) released an advance copy of Revenue Procedure 2020-19 (the “2020 Revenue Procedure”), which temporarily reduces the minimum required amount of cash that a RIC or REIT must be prepared to distribute to its shareholders. The 2020 Revenue Procedure modifies earlier guidance issued in 2017 (Revenue Procedure 2017-45), which established a safe harbor rule on distributions as to which shareholders can elect to receive stock or cash. Under the Revenue Procedure 2017-45 safe harbor, if certain conditions are met, both the distribution of stock and the distribution of cash will count as dividends for purposes of the dividends-paid deduction.
The relevance of this is that for a RIC or REIT to preserve its favorable tax status and to avoid corporate-level tax, it must pay out its net taxable income and gains each year in the form of dividends. Most RICs and REITs have dividend-reinvestment plans, under which shareholders may elect to receive their dividends in the form of additional shares of stock rather than cash. For a distribution to qualify as a dividend for tax purposes, however, at least a certain percentage of the distribution has to be available to be made in cash for shareholders who so elect.
Originally, Revenue Procedure 2017-45 established that in cases in which the shareholders have an option to choose a distribution of either cash or stock with respect to the applicable RIC or REIT, the “Cash Limitation Percentage” — i.e., the minimum amount of cash (as opposed to stock) that the RIC or REIT must be prepared to distribute — cannot be less than 20%. The 2020 Revenue Procedure reduces the Cash Limitation Percentage from 20% to 10%. This reduction is temporary, however: it applies only to distributions declared on or after April 1, 2020, and on or before December 31, 2020.