Regulated Investment Company Requirements: The Ultimate 2026 Checklist

What is a Regulated Investment Company (RIC)?

A Regulated Investment Company (RIC) is a specific type of corporation in the United States, typically a mutual fund or an exchange-traded fund (ETF), that meets certain requirements under the Internal Revenue Code (IRC). The primary advantage of meeting the regulated investment company requirements is a special tax status that allows the company to act as a pass-through entity for its earnings. This structure is highly popular in the investment world because it avoids the issue of double taxation that standard corporations face. By distributing its income to shareholders, a RIC can deduct those dividends, meaning the income is only taxed at the shareholder level. This guide provides a comprehensive checklist for the RIC qualification tests and ongoing compliance for 2026.

Understanding the Role of Subchapter M in the IRC

The rules governing RICs are found in Subchapter M of the Internal Revenue Code (specifically, Sections 851 through 855). This section was created to encourage individual investors to pool their money in diversified portfolios managed by professionals. Subchapter M lays out the strict criteria a company must satisfy to qualify for and maintain its status as a RIC. These rules ensure that the company is primarily engaged in investing in securities and that it passes its earnings on to its investors. Failure to meet these technical requirements can result in the loss of this favorable tax treatment, making compliance a top priority for fund managers.

The Core Benefit: Avoiding Corporate Double Taxation

Imagine a standard corporation earns a profit. First, the corporation pays corporate income tax on those earnings. Then, when it distributes the remaining profits to shareholders as dividends, the shareholders pay personal income tax on that dividend income. This is known as “double taxation.”

A RIC avoids this. By meeting the regulated investment company requirements, particularly the distribution rules, the company can pass its income directly to shareholders. The RIC itself pays little to no corporate income tax. The income is taxed only once, at the shareholder level, preserving more of the investment returns for the end investor. This tax-efficient structure is a cornerstone of the modern investment fund industry.

The 3 Essential Tests to Qualify as a RIC

To qualify for the tax benefits of a RIC, a company must satisfy three core tests annually. These tests are designed to verify the company’s income sources, asset diversification, and commitment to distributing earnings. Mastering these RIC qualification tests is fundamental to operating a successful investment fund.

1. The 90% Gross Income Test: Defining “Good” Income

This test focuses on the source of the company’s income. At least 90% of a RIC’s gross income for each taxable year must be derived from what is considered “qualifying income.” This ensures the company is genuinely an investment vehicle and not an operating business.

Qualifying income generally includes:

• Dividends
• Interest
• Payments with respect to securities loans
• Gains from the sale or other disposition of stocks, securities, or foreign currencies
• Other income derived with respect to its business of investing in such stock, securities, or currencies

Income from sources like services rendered or non-investment-related activities is generally not considered qualifying income. This strict requirement keeps the focus of a RIC squarely on passive investment activities. For a broader view on investment strategies, including those involving advanced trading platforms like MT5, investors can explore various financial instruments.

2. The Asset Diversification Test: Breaking Down the 50% and 25% Rules

This test ensures that a RIC’s portfolio is adequately diversified, which protects investors from the risk of concentrating investments in a few securities. The asset test is measured at the end of each quarter of the taxable year and is broken into two parts:

The 50% Rule:

At least 50% of the RIC’s total assets must be invested in:

• Cash and cash items (including receivables).
• U.S. Government securities.
• Securities of other RICs.
• Other securities, where the investment in any single issuer is limited to no more than 5% of the RIC’s total assets and no more than 10% of the issuer’s outstanding voting securities.

The 25% Rule:

No more than 25% of the value of the RIC’s total assets may be invested in the securities of a single issuer (excluding U.S. Government securities and securities of other RICs). This rule prevents the fund from being overly concentrated in one company, even if it meets the 5% and 10% limits under the 50% rule.

3. The 90% Distribution Requirement: Distributing Earnings to Shareholders

This is arguably the most critical requirement for maintaining RIC tax status. A RIC must distribute at least 90% of its “investment company taxable income” to its shareholders each year. This is the core of the regulated investment company distribution requirements. This includes its net investment income (from dividends and interest) and the net of its short-term capital gains over its long-term capital losses.

By meeting this distribution threshold, the RIC can deduct the dividends paid to shareholders from its taxable income, effectively eliminating its own tax liability. Most RICs aim to distribute close to 100% of their income to avoid any corporate-level tax and potential excise taxes.

RIC Taxation Rules: A Pass-Through Entity Explained

The unique tax structure of a RIC is what makes it so advantageous. Understanding how both the company and its shareholders are taxed is crucial for investors.

How RICs Avoid Corporate-Level Tax

As mentioned, a RIC that meets the regulated investment company requirements and distributes at least 90% of its net investment income acts as a conduit. It is not taxed on the income it passes through to shareholders. If a RIC retains any of its income, it will be taxed at standard corporate rates on the retained amount. Furthermore, a 4% excise tax can apply if the RIC does not distribute a specified high percentage of its income (generally 98% of ordinary income and 98.2% of capital gains) within the calendar year.

Tax Implications for RIC Shareholders

Shareholders of a RIC receive distributions that are classified based on their original source. These are reported on Form 1099-DIV. The common types of distributions are:

• Ordinary Dividends: Taxed at the shareholder’s ordinary income tax rate.
• Qualified Dividends: A subset of ordinary dividends that are taxed at lower long-term capital gains rates.
• Capital Gain Distributions: Passed-through long-term capital gains, which are also taxed at the more favorable long-term capital gains rates.
• Tax-Exempt Dividends: If the RIC invests in municipal bonds, it can pass through the tax-exempt interest to shareholders.

This pass-through of character is a key feature, as it allows investors to benefit from the tax characteristics of the underlying investments. The concept of tax-efficient investing is a vital component of building a strong portfolio.

How to Elect and Maintain RIC Status

Becoming a RIC is a formal process that involves making an election with the IRS and adhering to strict ongoing compliance rules.

Filing Form 1120-RIC

A corporation elects to be treated as a RIC by computing its taxable income as a RIC on its tax return for the first year the election is to be effective. The form used for this is Form 1120-RIC, “U.S. Income Tax Return for Regulated Investment Companies.” Once this election is made, it is generally irrevocable and applies to all subsequent years, provided the company continues to meet the annual qualification tests.

Ongoing Compliance and Reporting Duties

Maintaining RIC status requires continuous monitoring and diligence. A fund must:

• Test its portfolio quarterly against the asset diversification rules.
• Track its income sources to ensure it meets the 90% gross income test.
• Manage its distributions to satisfy the 90% distribution requirement and avoid excise taxes.
• Maintain detailed records and file Form 1120-RIC annually.
• Provide shareholders with Form 1099-DIV detailing the tax character of distributions.

For investors and fund managers, ensuring the safety of funds and adherence to regulatory standards is paramount. This includes both the operational security of the trading platform and the compliance of the investment vehicle itself.

Conclusion

Meeting the regulated investment company requirements is a complex but essential process for any entity wishing to operate as a mutual fund, ETF, or other pooled investment vehicle in the United States. The benefits, primarily the avoidance of corporate double taxation, are significant and directly enhance shareholder returns. By diligently satisfying the 90% Gross Income Test, the Asset Diversification Test, and the 90% Distribution Requirement, a company can achieve and maintain its favorable RIC status, providing a transparent and tax-efficient conduit for investors to access diversified markets.

FAQ

1. What happens if a RIC fails one of the qualification tests?

If a RIC fails to meet one of the tests, it may be disqualified and lose its pass-through tax status for that year. This would mean the company is taxed as a standard C corporation, leading to double taxation. However, the IRC includes certain cure provisions that may allow a RIC to remedy a failure (often by paying a penalty tax) and retain its status, provided the failure was due to reasonable cause and not willful neglect.

2. Can a Real Estate Investment Trust (REIT) also be a RIC?

No, a company generally cannot be both a REIT and a RIC simultaneously. While both are pass-through entities governed by Subchapter M of the IRC and share similar concepts (income tests, asset tests, and distribution requirements), their underlying investments are different. REITs must primarily invest in real estate assets, while RICs must primarily invest in stocks and securities.

3. Are all mutual funds and ETFs considered Regulated Investment Companies?

The vast majority of U.S.-based mutual funds and ETFs are structured as RICs to take advantage of the pass-through tax treatment. It is the industry standard structure. However, some investment products, particularly those that invest heavily in commodities or use complex derivative strategies, may be structured as other entities, like partnerships or grantor trusts, which have different tax implications.

4. How does a RIC handle capital losses?

A RIC cannot pass through net capital losses to its shareholders. Instead, a RIC must carry over its net capital losses to offset future capital gains. These carryforwards can be used indefinitely to reduce the amount of capital gain distributions the RIC must make in future years, which can be a tax-efficient way to manage the portfolio.