SECTION 2. BACKGROUND

Certain money market funds seek investments with a yield that reflects current short-term exempt interest rates and that is treated for federal income tax purposes as being composed of interest exempt from tax under § 103. For purposes of this revenue procedure, a money market fund is a fund described in the Securities and Exchange Commission’s Rule 2a–7 (Rule 2a–7), 17 CFR 270.2a–7, issued under the Investment Company Act of 1940, 15 U.S.C. 80a–1 et seq . One investment that offers these advantages is an instrument that might be described as a synthetic tax-exempt variable-rate bond. To create such an instrument, a sponsor or an affiliate (the Sponsor) purchases (either at original issue or on the secondary market) an obligation the interest income on which is excluded under § 103 (§ 103 obligation) and transfers the § 103 obligation to an entity that qualifies as a partnership for federal tax purposes (taxexempt bond partnership). The taxexempt bond partnership issues two classes of equity interests: a preferred

interest that is entitled to a variable return on its capital contribution (preferred interest), and a second class of ownership interest that is entitled to all of the remaining income of the partnership (residual interest). The variable return on the preferred interest tracks current shortterm exempt yields.

Under § 702(b), if a partnership receives income that is exempt from tax under § 103, the income retains its character when the partnership allocates it to a partner. Under § 706(a), a partner includes in taxable income for a taxable year the partner’s allocable share of items of partnership income, gain, loss, deduction, and credit for the partnership’s taxable year ending within or with the partner’s taxable year.

Section 852(a) provides generally that a regulated investment company (RIC), including a RIC that is a money market fund, must distribute each taxable year at least 90 percent of its net interest income that is excludible from gross income under § 103(a). Section 852(b)(5) provides that if, at the close of each quarter of the RIC’s taxable year, at least 50 percent of the value (as defined in § 851(c)(4)) of the total assets of the RIC consists of obligations described in § 103(a), the RIC is qualified to pay exempt-interest dividends (as defined in § 852(b)(5)(A)) to its shareholders. Under § 852(b)(5)(A), an exempt-interest dividend means any dividend or part thereof paid by a RIC and designated by the RIC as an exempt-interest dividend in a written notice mailed to its shareholders not later than 60 days after the close of the RIC’s taxable year.

To maintain a constant net asset value for each share of stock, as is described in Rule 2a–7, money market funds commonly declare dividends daily and pay dividends monthly. (In this paragraph and the next, the word “dividend” refers to a distribution that is treated as a dividend for purposes of state corporate law and federal securities law, whether or not the distribution is also treated as a dividend for purposes of the Code.) In the case of a money market fund that intends to pay exempt interest dividends, substantially all of the fund’s income typically will be exempt from tax under § 103. If, however, such a money market fund has a

2002–9 I.R.B. 572 March 4, 2002

(2) A statement that the partnership elects a monthly closing of the books for all present and future consenting eligible partners;

(3) The signature of a person with authority to sign the partnership’s Form 1065, U.S. Return of Partnership Income ; and

(4) The effective month of the election. The election is effective for the calendar month in which the election is filed, unless the partnership requests the election to be effective for either of the two immediately preceding calendar months. For example, if a calendar year partnership states that the monthly closing system is to begin for June, the partnership will close its books June 30. Consenting eligible partners must include their shares of partnership items and guaranteed payments for the period from the last closing of the books (generally December 31 of the prior year) through June 30. There will be a closing of the books and a monthly inclusion of the partner’s share of these items and guaranteed payments at the end of each future month.

.02 Time for Making the Election . The partnership’s Monthly Closing Election may be made at any time. See, however, section 6.03 of this revenue procedure for limitations on the time for a partner to effect a Monthly Closing Consent.