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.
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