New York Advisory Opinion TSB-A-86 (10)I: For a multi-series municipal bond mutual fund where each series holds only one state's bonds, should the Tax Law § 612(b)(1) addback for non-New-York-bond interest be computed using the whole fund's total exempt interest, or only the exempt interest of the specific series the shareholder owns?

Plain-English summary

Attorney Brian E. Lorenz asked the Department to resolve a computational question for a tax-exempt municipal bond mutual fund he was helping incorporate as a "series fund" - a single regulated investment company (under IRC § 851) that issues multiple series of stock, each with its own distinct investments, segregated assets, and dedicated shareholders. In this particular fund, each series would hold only one state's municipal bonds (e.g., a "New York Series" holding only New York bonds), and shareholders in one series would have no ownership rights or claim to the assets or distributions of any other series.

Under Tax Law § 612(b)(1), a New York taxpayer must add back to federal adjusted gross income any interest income on obligations of a state OTHER than New York (or its political subdivisions) that wasn't already included in federal adjusted gross income - and the Department's own 1980 precedent (Municipal Fund for Temporary Investment) confirms exempt-interest dividends from a regulated investment company count as "interest" for this purpose, since such dividends are otherwise excluded from federal gross income under IRC §§ 103(a) and 852(b)(5)(b). The computational question was how to measure "the proportion" of a shareholder's exempt-interest dividend attributable to non-New-York-bond interest: based on the total exempt interest earned by the ENTIRE fund across all its series, or only by the specific series the shareholder actually owns.

The Department sided with the series-specific approach. It noted that a prior 1977 notice from the Director of the Income Tax Bureau had instructed taxpayers to compute the addback based on the fund's total exempt interest - a method that works fine for an ordinary single-series fund, but breaks down for a multi-series fund because it ignores the fact that a shareholder in one series has no ownership rights whatsoever in another series' assets or income. Since the articles of incorporation for this fund would segregate each series' assets, income, and distributions entirely, the Department concluded that the addback should be based on the proportion that non-New-York-bond interest represents of the total federal exempt interest earned specifically by the series in which the shareholder holds an interest - not the fund-wide total. This effectively narrowed the 1977 notice's applicability going forward to single-series funds.

What this means for you

Investors in multi-series municipal bond mutual funds

If you own shares in one series of a multi-series tax-exempt bond fund (for example, a series dedicated to your home state's bonds), your section 612(b)(1) addback for non-New-York-bond interest should be computed based on your OWN series' exempt interest income, not the entire fund's combined exempt interest across all its series - a meaningfully different (and typically more favorable, if your series holds mostly New York bonds) result than a fund-wide calculation would produce.

Fund sponsors and administrators structuring multi-series municipal bond funds

When providing shareholders with the information needed to compute their New York addback, report each series' own exempt-interest breakdown separately rather than a single fund-wide figure - this opinion confirms that a fund-wide computation misstates the result for any shareholder in a series that isn't representative of the fund as a whole.

Accountants preparing returns for clients holding regulated investment company shares

Don't automatically apply the fund-wide proportion method described in older Department guidance (the 1977 notice) without first checking whether the fund is structured with multiple, ownership-segregated series - this opinion confirms that method is simply the wrong tool for that fund structure.

Common questions

Q: I own shares in one series of a multi-series municipal bond fund - how do I calculate my New York addback for non-New-York-bond interest?
A: Based on the proportion that non-New-York-bond interest represents of the total federal exempt interest earned by YOUR series specifically, not the entire fund's combined exempt interest across all its series.

Q: Doesn't a 1977 Department notice say to use the fund's total exempt interest?
A: That notice worked for an ordinary single-series fund, but the Department found it doesn't account for a shareholder's limited ownership rights in a true multi-series fund, where each series' assets and income are legally segregated. For a multi-series fund, use the series-specific computation described in this opinion instead.

Q: Are exempt-interest dividends from a mutual fund even treated as "interest" for the section 612(b)(1) addback?
A: Yes. The Department confirmed this in its earlier Municipal Fund for Temporary Investment opinion, and reaffirmed it here - exempt-interest dividends, though excluded from federal gross income under IRC §§ 103(a) and 852(b)(5)(b), are still "interest" for purposes of the New York addback on non-New-York-bond interest.

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1986.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a86_10i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-86 (10) I
Income Tax
July 30, 1986

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. I860423A

On April 23, 1986, a Petition for Advisory Opinion was received from Brian E. Lorenz, Esq.,
Carro, Spanbock, Fass, Geller, Kaster and Cuiffo, 1345 Avenue of the Americas, New York, New
York 10105.
The issue raised involves the method of computation of the portion of regulated investment
company exempt interest dividends which represents the amount of interest of other states required
to be added back to Federal adjusted gross income pursuant to the provisions of section 612(b)(1)
of the Tax Law. Petitioner asks whether such computation should be based upon the proportion that
such interest for the distribution period is of the total Federal exempt interest, whether distributed
or not, received by the regulated investment company during the distribution period or will be based
upon the proportion that such interest for the distribution period is of the total Federal exempt
interest, whether distributed or not, received during the distribution period by the series in which the
shareholder has an ownership interest.
Petitioner is an attorney who is involved in the incorporation of a tax exempt series fund.
Petitioner states that the articles of incorporation and the operations of the tax exempt fund will be
in accordance with section 851 of the Internal Revenue Code, thereby qualifying as a regulated
investment company.
Ordinarily, regulated investment companies, commonly known as mutual funds, are
incorporated as a single entity authorized to issue stock in different series with each series having
its own distinct investment objectives and shareholders.
Series of a mutual fund may include an income series, utilities series and/or growth series.
The subject of this petition is a municipal bond fund (tax exempt fund), which also uses a series
format, each series specializing in the municipal bonds of a particular state. Each series in the tax
exempt fund will be comprised of obligations of a particular state. Each series operates as a separate
investment company or fund, even though the tax exempt fund is organized as a single regulated
investment company.
The articles of incorporation of the tax exempt municipal bond fund, in accordance with the
Investment Act of 1940, will provide that all assets received as consideration for the issue or sale of
shares of stock of a series together with all income, earnings, profits and proceeds shall appertain
to such class of stock, shall constitute the assets of such class of stock and shall be so segregated
upon the books of account. For example, shareholders owning an interest only in the one series
investing primarily in municipal bonds of New York State (New York Series) are entitled to receive
dividends and other distributions only from the investments owned by the New York Series. The
shareholders would have no right or claim to distributions from securities constituting series
investing in other state's municipal bonds.
RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

-2­
TSB-A-86 (10) I
Income Tax
July 30, 1986

Exempt interest dividends are paid by a regulated investment company when at least 50%
of the value of the total assets of the fund consist of obligations of a State, a Territory or a possession
of the United States or any political subdivision of any of the foregoing or of the District of
Columbia. Exempt interest dividends issued by a regulated investment company are excluded from
Federal gross income pursuant to sections 103(a) and 852(b)(5)(b) of the Internal Revenue Code.
Such income is therefore not included in Federal adjusted gross income, which is the starting point
in computing taxable income under New York's Personal Income Tax.
Section 612(b)(1) of the New York State Tax Law requires an addition to Federal adjusted
gross income in computing New York adjusted gross income of "interest income on obligations of
any state other than this state, or of a political subdivision of any such other state ... to the extent not
properly includible in federal adjusted gross income". There is no such required addition of interest
income from obligations of the State of New York or its political subdivisions. Exempt interest
dividends constitute interest for the purposes of the provision of the Tax Law here referred to.
Municipal Fund for Temporary Investment, Inc., State Tax Commission Advisory Opinion, July 18,
1980, TSB-H-80-(245)-I.
Petitioner points out that a notice from the Director of the New York State Income Tax
Bureau dated March 7, 1977 provides that the amount of exempt interest dividends on obligations
other than those of New York State's that is included in New York's adjusted gross income is based
upon the proportion that such interest is of the total Federal exempt interest received by the regulated
investment company during the distribution period. Such notice is consistent with a regulated
investment company consisting of a single series but inconsistent with a multiple series regulated
investment company in that it fails to take into account the limited ownership rights of an owner of
shares in a single series of a multiple series regulated investment company.
Accordingly, the portion of each shareholder's exempt interest dividend which represents the
amount of his modification to Federal adjusted gross income, for the amount attributable to interest
on obligations of states other than those of New York State or its political subdivisions should be
based upon the proportion that such interest, for the distribution period, is of the total Federal exempt
interest income, whether distributed or not, earned by the series of the municipal bond fund in which
the shareholder has an ownership interest. It need not be based upon the total Federal exempt interest
received by the regulated investment company as indicated by the March 7, 1977 notice.

DATED: July 30, 1986

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.