When were municipal-bond fund dividends exempt from South Carolina income tax for South Carolina shareholders?

Plain-English summary

South Carolina Private Letter Ruling 87-6 reached three related conclusions about government-obligation interest and municipal-bond fund dividends:

1. Interest earned directly on obligations of South Carolina or its political subdivisions was exempt from South Carolina income tax. Interest on obligations of U.S. territories or possessions was exempt only to the extent provided by federal law.
2. ABC's National Series could not pay South Carolina exempt-interest dividends because only about 10% of its assets were South Carolina-exempt securities, below the ruling's 50% qualification test.
3. Dividends from a South Carolina Series invested solely in South Carolina-exempt securities were exempt when paid to South Carolina shareholders.

ABC Fund's series structure

ABC Fund was a regulated investment company under Subchapter M of the Internal Revenue Code and intended to maintain that status.

It offered a National Series and multiple State Series.

The National Series aimed to maximize federally tax-exempt income. Under normal market conditions it planned to invest 100%, but never less than 80%, of its assets in tax-exempt obligations of states, territories, and U.S. possessions. Approximately 10% of its assets were South Carolina-exempt securities.

Each State Series was a segregated choice for subscribers. The South Carolina Series aimed to maximize income exempt from both federal and South Carolina personal income tax. Under normal conditions it planned to invest 100%, but never less than 80%, in South Carolina-exempt securities.

Directly held government-obligation interest

Section 12-7-410 began with federal individual income, subject to South Carolina modifications.

Section 12-7-430(b) modified the federal section 103 exclusion so that South Carolina exempted interest on obligations of:

• South Carolina;
• South Carolina political subdivisions; and
• the United States.

South Carolina's statute did not itself exempt interest on obligations of U.S. territories or possessions. The ruling allowed that interest to remain exempt only where the United States Code provided the exemption.

The 50% fund qualification test

Internal Revenue Code section 852(b)(5), as adopted and modified by South Carolina in the ruling, allowed a regulated investment company to pay exempt-interest dividends if at least 50% of its asset value at each quarter-end consisted of qualifying obligations.

For a regulated investment company with more than one fund, the cited series-fund rule treated each segregated fund as a separate corporation for the relevant tax analysis.

South Carolina references to federal section 103 were modified to mean South Carolina-exempt securities. Each series therefore had to satisfy the 50% test using securities exempt for South Carolina purposes.

Why the National Series failed

Only about 10% of the National Series assets were South Carolina-exempt securities.

Even if its distributions were federally designated as exempt-interest dividends, the series did not meet South Carolina's 50% qualifying-asset threshold. Its dividends therefore did not qualify as South Carolina exempt-interest dividends under the ruling.

Why the South Carolina Series qualified

The ruling's favorable conclusion assumed that the South Carolina Series invested solely in South Carolina-exempt securities and paid dividends qualifying under federal section 852(b).

On those facts, all dividends paid by that series to South Carolina shareholders were exempt from South Carolina income tax.

What this means for you

Municipal-bond fund managers

PLR 87-6 applied the asset test separately to each fund series. A national portfolio's federal tax-exempt character did not automatically make its dividends exempt in South Carolina.

South Carolina-focused funds

The ruling approved full exemption for a series invested solely in South Carolina-exempt securities, assuming the distributions otherwise met the exempt-interest-dividend rules.

South Carolina investors

The source of the underlying interest mattered. A national municipal-bond fund could hold mostly federally exempt bonds while failing the state's qualifying-asset test.

Fund tax and reporting teams

The ruling tied shareholder treatment to the series' asset composition and proper designation of exempt-interest dividends.

Readers applying the ruling today

PLR 87-6 applied 1987 state conformity and federal regulated-investment-company provisions. Current asset tests, fund-series rules, state-specific percentages, designation notices, territory-bond statutes, and shareholder reporting must be checked independently.

Common questions

Q: Was direct interest on South Carolina bonds exempt?

A: Yes. The ruling exempted obligations of South Carolina and its political subdivisions.

Q: Was interest on territory or possession bonds always exempt?

A: No. South Carolina's statute did not itself exempt that interest; exemption depended on federal law.

Q: Why did the National Series fail?

A: Only about 10% of its assets were South Carolina-exempt securities, below the required 50%.

Q: Did each series receive separate testing?

A: Yes. The cited series-fund provision treated each segregated fund separately.

Q: Were all South Carolina Series dividends exempt?

A: Yes under the ruling's stated assumption that the series invested solely in South Carolina-exempt securities and paid qualifying exempt-interest dividends.

Q: Can another fund or shareholder rely on PLR 87-6?

A: No. The ruling states that it applied only to ABC Fund's specific facts, had no precedential value, and was not intended for distribution.

Citations and references

• S.C. Code sections 12-7-410 and 12-7-430(b) — South Carolina individual income and exempt-interest modifications
• Internal Revenue Code section 103 — federal tax-exempt obligation interest referenced by the ruling
• Internal Revenue Code section 851(q), also shown as 851(h) in the ruling — separate treatment of series funds
• Internal Revenue Code section 852(b)(5) — exempt-interest dividends and shareholder treatment
• S.C. Code section 12-3-170 — private-letter-ruling authority

Source

• Landing page: https://dor.sc.gov/advisory-opinion-search
• Original PDF: https://dor.sc.gov/sites/dor/files/policies/PLR87-6.pdf

Original ruling text

SC PRIVATE LETTER RULING #87-6

TO:

ABC Fund, Inc.

SUBJECT:

Exempt Interest-Dividends

REFERENCE:

S.C. Code Section 12-7-410; 12-7-430

AUTHORITY:

S.C. Code Section 12-3-170

SCOPE:

A Private Letter Ruling is a temporary document issued to a taxpayer,
upon request, and it applies only to the specific facts or circumstances
related in the request. Private Letter Ruling have no precedential value
and are not intended for distribution.

Question:
1)

Is the interest earned on investments in obligations of the State of South Carolina or its
political subdivisions and obligations of territory or possessions of the United States
exempt from South Carolina income tax if held directly by a South Carolina taxpayer?

2)

If all dividends paid by the National Series are exempt-interest dividends as that term is
defined in IRC Section 852(b), is the prorata share of such dividends paid to South
Carolina shareholders which corresponds to the share of interest earned by the fund from
South Carolina "exempt securities" exempt from South Carolina income tax?

3)

If all dividends paid by the South Carolina series are "exempt-interest dividends" as that
term is defined in IRC Section 852(b) of the Internal Revenue Code of 1986 and if the
South Carolina series invests solely in South Carolina exempt securities, are all dividends
paid to South Carolina shareholders exempt from South Carolina income tax?

Facts:
The ABC Fund, Inc. is a regulated investment company under Subchapter M of the Internal
Revenue Code. The Fund has taken and intends to continue to take all action required to insure
that it meets the requirements to retain its status as a regulated investment company. The Fund
offers a National Series and several State series.

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The investment objective of the National Series is to maximize income exempt from federal
income tax. The National Series will invest 100%, under normal market conditions, but never
less than 80% of the value of its assets in securities of states, territories and possessions of the
United States, the interest of which is exempt from federal income tax. Approixmately 10% of
the assets of the National Series are South Carolina exempt securities.
The Fund also offers a State Series. A subscriber must indicate that he wishes to purchase a
specific State Series. The objective of each individual State Series is to maximize income
exempt from federal income taxes and from personal income taxes in that state. The South
Carolina Series will invest 100% of its assets under normal market conditions but never less than
80% of the value of its assets in South Carolina exempt securities i.e. securities that bear interest
which is exempt from South Carolina income taxes.
Law/Discussion
South Carolina Code Section 12-7-410 provides:
The South Carolina gross income, adjusted gross income, and taxable income of an
individual is the individual's gross income, adjusted gross income, and taxable income as
determined under the Internal Revenue Code with the modifications specified in Sections
12-7-430 and 12-7-435.
South Carolina Code Section 12-7-430(b) provides:
The determination of gross income as provided in the following Internal Revenue Code
Sections is made with the following modifications:
(1)

The exclusion from gross income authorized by Internal Revenue Code Section 103
is modified to exempt only interest upon obligations of this State, any of its political
subdivision, and to exempt interest upon obligations of the United States.

(2)

In any and all Internal Revenue Code Sections that make reference to Internal
Revenue Code Section 103, the modification provided in sub-item (1) of item (b) of
this section similarly applies.

Internal Revenue Code Section 851(q)[(h)]
(q)[(h)] Special Rule for Series Funds
(1)

In General - In the case of a regulated investment company (within the meaning of
subsection (a)) having more than one fund, each fund of such regulated investment
company shall be treated as a separate corporation for purposes of this title (except
with respect to the definitional requirement of subsection (a)).

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(2)

Fund Defined - For purposes of paragraph (1) the term "fund" means a segregated
portfolio of assets, the beneficial interests in which are owned by the holders of a
class or series of stock of the regulated investment company that is preferred over
all other classes or series in respect of such portfolio assets.

Internal Code Section 852(b) (5) provides:
Exempt-interest dividends. - If, at the close of each quarter of its taxable year, at least 50
percent of the value (as defined in Section 851(c) (4) of the total assets of the regulated
investment company consists of obligations described in section 103(a), such company
shall be qualified to pay exempt-interest dividends, as defined herein, to its shareholders.
(A) Definition. - An exempt-interest dividend means any dividend or part thereof (other
than a capital gain dividend) paid by a regulated investment company and
designated by it as an exempt-interest dividend in a written notice mailed to its
shareholders not later than 45 days after the close of its taxable year. If the
aggregate amount so designated with respect to a taxable year of the company
(including exempt-interest dividends paid after the close of the taxable year as
described in Section 855) is greater than the excess of(i) the amount of interest excludable from gross income under section 103(a), over
(ii) the amounts disallowed as deductions under sections 265 and 171(a)(2), the
portion of such distribution which hall be only that proportion of the amount so
designated as the amount of such excess for such taxable year bears to the
amount so designated.
(B) Treatment of exempt-interest dividends by shareholders. – An exempt-interest
dividend shall be treated by the shareholders for all purposes of this subtitle as an
item of interest excludable from gross income under Section 103(a). Such purposes
include but are not limited to(i) the determination of gross income and taxable income.
(ii) the determination of distributable net income under subchapter J,
(iii) the allowance of, or calculation of the amount of, and credit or deduction, and
(iv) the determination of the basis in the hands of any shareholder of any share of
stock of the company.
South Carolina law exempts all interest upon obligations of this State and its political
subdivisions and obligations of the United States. Interest upon obligations of territories or
possessions of the United Sates is not exempted by South Carolina Statute, however, the interest
of certain obligations of territories or possessions of the United States is exempted by the United
States Code.
South Carolina adopted IRC Sections 851 and 852 providing for taxation of a Regulated
Investment Company and its shareholders as part of the 1985 Conforming Amendments. The
1986 amendments to Sections 851 and 852 have also been adopted by South Carolina. In
determining South Carolina taxable income, references to IRC Section 103 that appear in these

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sections are modified as provided by S.C. Section 12-7-430(b)(2). Therefore, to qualify as
exempt-interest dividends under IRC Section 852(b)(5), at least 50 percent of the value of the
total assets of the regulated investment trust company (or each separately considered fund as
provided by Section 851(q) [(h)] must consist of South Carolina tax exempt securities.
Conclusion:
1)

Interest earned on investments in obligations of the State of South Carolina or its political
subdivisions is exempt from South Carolina income tax if held directly by a South
Carolina taxpayer. Interest earned on investments in obligations of territories or
possessions of the United States is held exempt from South Carolina income tax to the
extent provided by the United States Code.

2)

Dividends paid by the National Series would not qualify as exempt-interest dividends as
at least 50% of the fund is not South Carolina exempt securities.

3)

All dividends paid by the South Carolina Series are exempt-interest dividends if the fund
invests solely in South Carolina exempt securities and thus exempt from income tax
when paid to South Carolina Shareholders.

SOUTH CAROLINA TAX COMMISSION

s/S. Hunter Howard Jr.
S. Hunter Howard, Jr., Chairman

s/John M. Rucker
John M. Rucker, Commissioner

s/Howard E. Duvall Jr.
Howard E. Duvall, Jr., Chairman
Columbia, South Carolina
June 4
, 1987

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