What is a Regulated Investment Company?
A regulated investment company (RIC) is an investment company in the United States which is registered under the Investment Company Act of 1940, a law passed by Congress in response to concerns about the financial market and questions about unclear definitions for certain types of financial companies. Under the rules which govern regulated investment companies, the company is allowed to directly distribute profits such as interest, capital gains, and dividends to shareholders, and shareholders are taxed on an individual level for these earnings while the company is not. The purpose of this system is to eliminate double taxation, in which the company would pay tax and investors who would pay tax again on the same earnings.
Mutual funds are commonly regulated investment companies, and it is also possible for real estate investment trusts (REITs) to register under the Act. In order to stay registered, companies need to meet certain requirements set forth by the government and to be able to demonstrate adherence to these requirements. Additional requirements must be met to avoid double taxation; simply being registered, in other words, does not exempt a regulated investment company from tax liability.
To avoid paying federal taxes, a regulated investment company must pay out 90% of its profits to investors. However, the company will still be liable for a four percent excise tax unless it pays out 98% of its profits. Such companies are allowed to charge fees to investors to cover the costs of operating the fund, which can include everything from covering fees for transfers of stocks to fees for legal paperwork which needs to be filed.
IRS Regulation M pertains to the operation of regulated investment companies. When an investor has money invested with a regulated investment company, the investor is required to pay taxes on payouts, even if they are reinvested. This ensures that tax is collected at the time the income is made, preventing tax avoidance tactics which might otherwise be used to conceal or move the income to reduce tax liability.
Double taxation is regarded as unfair in most settings, because it is deemed unreasonable to be expected to pay taxes twice on the same earnings, even if the taxes are paid by two different individuals or entities. Establishing a regulated investment company allows financial companies to avoid this problem, which in turn means that they can generate more profits for their investors because they are not making tax payments.
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