Bernstein Government Short Duration Portfolio, a series of the Sandford C. Bernstein Fund, Inc. (a registered open-end mutual fund), asked whether the term 'obligations of the United States' in Tax Law § 612(c)(1) - which governs the regulated investment company (RIC) pass-through exemption for interest-dividends - includes obligations of federal agencies (not just direct US Treasury obligations), such as those specifically enumerated in Technical Services Bureau Memorandum TSB-M-86(8)I.

Plain-English summary

Bernstein Government Short Duration Portfolio, a series of the Sandford C. Bernstein Fund, Inc. (a registered open-end management investment company, i.e., a mutual fund), asked the Department a scope question: does "obligations of the United States" in Tax Law § 612(c)(1) - the provision that lets a regulated investment company (RIC) pass through federal-obligation interest to its shareholders as exempt income - reach beyond direct US Treasury securities to also include obligations of federal agencies, such as those specifically listed in Technical Services Bureau Memorandum TSB-M-86(8)I? Petitioner argued that the purpose of the 1986 legislation, ordinary rules of statutory construction, and the meaning given to "obligations of the United States" in other contexts all pointed toward including federal agency obligations within the exemption.

Tax Law § 612(c)(1), as amended by Chapter 535 of the Laws of 1986, lets a taxpayer subtract from federal adjusted gross income interest income on obligations of the United States and its possessions. That subtraction extends to dividends received from a RIC, so long as the RIC designates the dividend as such interest in a written notice to shareholders within 45 days after the close of its taxable year, and at least 50% of the RIC's assets (tested at the close of each quarter, under IRC § 851(c)) consist of US or possessions obligations. Chapter 535 was enacted specifically so that individuals who invest in US government obligations indirectly through a RIC would be treated the same, for New York tax purposes, as individuals who buy those same obligations directly (NY Legis Ann, 1986, p. 246).

Rather than issuing a freestanding definition of which federal agencies qualify, the Department answered by pointing to its own existing guidance: Technical Services Bureau Memorandum TSB-M-86(8)I lists specific obligations issued by the United States government, by states, and by municipalities, and states for each one whether its interest is subject to New York tax. The Department noted that this list is "not all inclusive," but that taxpayers should consult it when applying the section 612(b) and (c) modifications. Because RIC dividends attributable to investments in "obligations of the United States and its possessions" are treated as interest income under § 612(c)(1), individual investors should look to TSB-M-86(8)I to determine which specific obligations - including certain federal agency obligations - qualify.

The opinion also flags an important limitation that cuts the other way: where a RIC instead invests its assets in repurchase agreements whose underlying collateral consists of US obligations, the income the RIC earns from those repurchase agreements is not treated as interest income on "obligations of the United States and its possessions." That repo income is fully taxable to individual New York recipients, per Technical Services Bureau Memorandum TSB-M-88(5)I - because a repurchase agreement is a secured loan collateralized by a US security, not a direct ownership interest in the obligation itself, so its return is ordinary loan interest rather than exempt federal-obligation interest.

What this means for you

Mutual fund investors holding government-bond funds

If you own shares in a fund like this one that invests in US government and federal agency obligations, the portion of your dividend the fund designates (in writing, within 45 days of its fiscal year-end) as interest on "obligations of the United States and its possessions" can be subtracted from federal adjusted gross income on your New York return - provided the fund meets the 50%-of-assets test each quarter. Whether a particular federal agency obligation counts depends on the specific obligation; check TSB-M-86(8)I's list (or your fund's own tax disclosures, which typically track it) rather than assuming every "government" or "agency" fund holding automatically qualifies.

Fund managers deciding what to designate as exempt-interest dividends

When designating the exempt-interest portion of a RIC's dividend under § 612(c)(1), don't lump together income from direct ownership of qualifying US and federal agency obligations with income the fund earned from repurchase agreements collateralized by US securities. This opinion makes clear that repo income is a different animal for New York tax purposes - it is fully taxable to individual shareholders even though the collateral behind the repo is itself a US obligation - so it should be excluded from the exempt-interest designation.

Accountants distinguishing direct-obligation interest from repo income

When reviewing a client's RIC year-end tax statement, confirm which income streams the fund is designating as § 612(c)(1) interest. Consult TSB-M-86(8)I to check whether specific federal agency holdings are on the Department's list of obligations whose interest is NY-exempt, and separately confirm that none of the designated amount traces back to repurchase-agreement income, which TSB-M-88(5)I treats as fully taxable regardless of the collateral's status as a US obligation.

Common questions

Q: Does "obligations of the United States" under Tax Law § 612(c)(1) include federal agency bonds, not just Treasuries?
A: The Department didn't issue a bright-line list of qualifying agencies in this opinion. Instead, it pointed to Technical Services Bureau Memorandum TSB-M-86(8)I as the governing reference - that memo lists specific obligations of the US government, states, and municipalities and states whether each one's interest is NY-taxable. Some federal agency obligations can be included, but which ones depends on that list (which the Department itself describes as "not all inclusive"), not on a categorical rule that every federal agency obligation automatically qualifies.

Q: If my government-bond fund invests in repurchase agreements, is that interest exempt too?
A: No. Even if the repo's underlying collateral is a US Treasury or other exempt obligation, the income the fund earns from the repurchase agreement itself is not treated as "interest income on obligations of the United States and its possessions" under § 612(c)(1). Per Technical Services Bureau Memorandum TSB-M-88(5)I, that repo income is fully taxable to individual New York recipients.

Q: Why does a repo not count the same as owning the underlying Treasury security?
A: A repurchase agreement is structured as a secured loan - the fund is effectively lending money with a US security posted as collateral - rather than a direct purchase and ownership of the obligation itself. Because the fund's return comes from the loan arrangement rather than from holding the government obligation directly, the Department treats it as ordinary interest income, not as exempt federal-obligation interest.

Q: What did the 1986 amendment (Chapter 535) to § 612(c)(1) actually change?
A: Before 1986, an individual who bought US government obligations directly could exclude the interest from New York income, but an individual who bought the same obligations indirectly through a RIC received a "dividend" rather than "interest," which arguably fell outside the exemption. Chapter 535 fixed that by extending the § 612(c)(1) subtraction to RIC dividends attributable to the fund's investment in US and possessions obligations, so long as the RIC designates the interest portion within 45 days of its fiscal year-end and meets the 50%-of-assets test each quarter.

Q: Where should I look to find out whether a specific federal agency obligation qualifies?
A: Consult Technical Services Bureau Memorandum TSB-M-86(8)I, which the Department identifies as its reference list of specific US, state, and municipal obligations and their New York tax treatment. Because the list isn't all-inclusive, an obligation's absence from it isn't necessarily determinative, but it is the starting point the Department directs taxpayers to use.

Citations and references

• Tax Law § 612(c)(1) (as amended by L.1986, ch.535) - subtracts from federal adjusted gross income interest on US/possessions obligations, including qualifying RIC dividends designated as such within 45 days of fiscal year-end, provided at least 50% of the RIC's assets are US/possessions obligations each quarter
• IRC § 851(c) - defines "value of total assets" used in the RIC 50%-obligations diversification test
• NY Legis Ann, 1986, p. 246 - legislative history explaining that Chapter 535 of the Laws of 1986 was enacted to equalize New York tax treatment of direct and RIC-indirect investment in US government obligations
• Technical Services Bureau Memorandum TSB-M-86(8)I - the Department's non-exhaustive reference list of specific US, state, and municipal obligations and whether interest on each is subject to New York tax
• Technical Services Bureau Memorandum TSB-M-88(5)I - holds that income from repurchase agreements collateralized by US obligations is not exempt "interest income on obligations of the United States" and is fully taxable to individual New York recipients

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1989.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a89_4i.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-89 (4) I
Income Tax
April 11, 1989

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I881208B

On December 8, 1988, a Petition for Advisory Opinion was received from Bernstein
Government Short Duration Portfolio of Sandford C. Bernstein Fund, Inc., 767 Fifth Avenue, New
York, New York 10153.
The issue raised is whether "obligations of the United States" as used in section 612(c)(1) of
the Tax Law with respect to the treatment of dividends from a regulated investment company
includes the obligations of federal agencies, such as those enumerated in TSB-M-86-(8)I.
Petitioner is a registered open-end management investment company. Petitioner contends that
(1) the purpose and intent of Chapter 535 of the Laws of 1986 which adopted the regulated
investment company (hereinafter "RIC") pass-through provisions for interest on federal obligations,
(2) the rules of statutory construction applied to the statute against the background of the legislative
history and (3) the meaning applied to the term "obligations of the United States" in other contexts,
each and in combination, require a conclusion that for purposes of the RIC pass-through provisions
of section 612(c)(1) "obligations of the United States" includes obligations of federal agencies such
as those listed in TSB-M-86-(8)I.
Section 612(c) of the Tax Law, as amended by Chapter 535 of the Laws of 1986, provides,
in part:
There shall be subtracted from federal adjusted gross income:
(1) Interest income on obligations of the United States and its possessions to the
extent includible in gross income for federal income tax purposes; such interest
income shall include the amount received as dividends from a regulated investment
company, as defined in section eight hundred fifty-one of the internal revenue code,
which has been designated as the amount of such interest income in a written notice
to shareholders not later than forty-five days following the close of its taxable year;
provided that, at the close of each quarter of the taxable year of such regulated
investment company, at least fifty percent of the value of its total assets, as defined
in subsection (c) of section eight hundred fifty-one of the internal revenue code,
consists of obligations of the United States and its possessions.
Chapter 535 of the Laws of 1986 was enacted to permit individuals who invest in United
States government obligations through RIC's to treat the income they receive therefrom as if they had
directly invested in such securities. Specifically, section 612(c)(1) of the Tax Law was amended to

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TSB-A-89 (4) I
Income Tax
April 11, 1989

provide that interest income on obligations of the United States and its possessions includes income
received from a RIC that is attributable to its investment in obligations of the United States and its
possessions. (See NY Legis Ann, 1986, p 246).
Technical Services Bureau Memorandum TSB-M-86-(8)I provides a list of obligations issued
by the United States government, states and municipalities, and states whether the interest on each
obligation is subject to New York State income tax. Such list is not all inclusive. However,
taxpayers should consult such list when computing the modifications contained in section 612(b) and
(c) of the Tax Law.
Since the dividends received by individuals from RIG's that invest in obligations of the
United States and its possessions is treated as interest income pursuant to section 612(c)(1), such
individuals may look to TSB-M-86-(8)I for guidance in determining what is meant by "obligations
of the United States and its possessions."
It should be noted that where the RIC invests its assets in repurchase agreements whose
subject matter consists of United States obligations, the income from such repurchase agreements
does not represent interest income from "obligations of the United States and its possessions" and,
thus, are fully taxable to the individual recipients for New York State income tax purposes. See
Technical Services Bureau Memorandum TSB-M-88-(5)I.

DATED: April 11, 1989

s/FRANK J. PUCCIA
Director
Technical Services

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