Interest and Penalties

Interest.   Interest is charged on taxes paid late even if an extension of time to file is granted. Interest is also charged on penalties imposed for failure to file, negligence, fraud, gross valuation overstatements, and substantial understatements of tax from the due date (including extensions) to the date of payment. The interest charge is figured at a rate determined under section 6621.

Penalty for late filing of return.   A fund that does not file its tax return by the due date, including extensions, may be penalized 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. The minimum penalty for a return that is over 60 days late is the smaller of the tax due or $100. The penalty will not be imposed if the fund can show that the failure to file on time was due to reasonable cause. Funds that file late must attach a statement explaining the reasonable cause.

Penalty for late payment of tax.   A fund that does not pay the tax when due generally may be penalized ½ of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax. The penalty will not be imposed if the fund can show that the failure to pay on time was due to reasonable cause.

Trust fund recovery penalty.   This penalty may apply if certain income, social security, and Medicare taxes that must be collected or withheld are not collected or withheld, or these taxes are not paid. These taxes are generally reported on Forms 941 or 945 (see Other Forms, Returns, Schedules and Statements That May Be Required on page 2). The trust fund recovery penalty may be imposed on all persons who are determined by the IRS to have been responsible for collecting, accounting for, and paying over these taxes, and who acted willfully in not doing so. The penalty is equal to the unpaid trust fund tax. See the instructions for Pub. 15 (Circular E), Employer's Tax Guide, for more details, including the definition of responsible person.

Other penalties.   Other penalties can be imposed for negligence, substantial understatement of tax, and fraud. See sections 6662 and 6663.

Specific Instructions

Period Covered

File the 2002 return for calendar year 2002 and fiscal years that begin in 2002 and end in 2003. For a fiscal year return, fill in the tax year space at the top of the form.

Note:   The 2002 Form 1120-RIC may also be used by the fund if:

• The fund has a tax year of less than 12 months that begins and ends in 2003 and
• The 2003 Form 1120-RIC is not available at the time the fund is required to file its return.

The fund must show its 2003 tax year on the 2002 Form 1120-RIC and take into account any tax law changes that are effective for tax years beginning after December 31, 2002.

Address

Include the suite, room, or other unit number after the street address.

If the Post Office does not deliver mail to the street address and the fund has a P.O. box, show the box number instead.

Item B-Date Fund Was Established

If this return is being filed for a series fund (as described in section 851(g)(2)), enter the date the fund was created. Otherwise, enter the date the RIC was incorporated or organized.

Item C-Employer Identification Number (EIN)

Enter the fund's EIN. If the fund does not have an EIN, it must apply for one on Form SS-4, Application for Employer Identification Number. If the fund has not received its EIN by the time the return is due, write Applied for in the space for the EIN. See Pub. 583 for details.

Item D-Total Assets

Enter the fund's total assets (as determined by the accounting method regularly used in keeping the fund's books and records) at the end of the tax year. If there are no assets at the end of the tax year, enter the total assets as of the beginning of the tax year.

Item E-Final Return, Name Change, Address Change, or Amended Return

• If the fund ceases to exist, file Form 1120-RIC and check the Final return box.
• If the fund changed its name since it last filed a return, check the box for Name change. Generally, a fund also must have amended its articles of incorporation and filed the amendment with the state in which it was incorporated.
• If the fund has changed its address since it last filed a return, check the box for Address change.
• If the fund is amending its return, check the box for Amended return, complete the entire return, correct the appropriate lines with the new information, and refigure the fund's tax liability. Attach a statement that explains the reason for the amendments and identifies the lines being changed on the amended return.

Note:   If a change in address occurs after the return is filed, use Form 8822, Change of Address, to notify the IRS of the new address.

Part I - Investment Company Taxable Income

Income

Line 1-Dividends

A fund that is the holder of record of any share of stock on the record date for a dividend payable on that stock must include the dividend in gross income by the later of (a) the date the share became an ex-dividend or (b) the date the company acquired the share.

Line 2-Interest

Enter taxable interest on U.S. obligations and on loans, notes, mortgages, bonds, bank deposits, corporate bonds, tax refunds, etc.

Do not offset interest expense against interest income.

Special rules apply to interest income from certain below-market-rate loans. See section 7872 for more information.

Line 3-Net Foreign Currency Gain or (Loss) From Section 988 Transactions

Enter the net foreign currency gain or (loss) from section 988 transactions that is treated as ordinary income or loss under section 988(a)(1)(A). Attach a schedule detailing each separate transaction.

Line 4-Payments With Respect to Securities Loans

Enter the amount received or accrued from a broker as compensation for securities loaned by the fund to the broker for use in completing market transactions. The payments must meet the requirements of section 512(a)(5).

Line 5-Excess of Net Short-Term Capital Gain Over Net Long-Term Capital Loss

Enter the excess of net short-term capital gain over net long-term capital loss from Schedule D (Form 1120), line 12.

Note:   Every sale or exchange of a capital asset must be reported in detail on Schedule D (Form 1120), even though no gain or loss is indicated.

Line 7-Other Income

Enter any other taxable income not reported on lines 1 through 6, except net capital gain that is reported in Part II. List the type and amount of income on an attached schedule. If the fund has only one item of other income, describe it in parentheses on line 7. Examples of other income to report on line 7 are:

• Gross rents.
• Recoveries of fees or expenses in settlement or litigation.
• The amount of credit for alcohol used as fuel (determined without regard to the limitation based on tax) entered on Form 6478, Credit for Alcohol Used as Fuel.
• Refunds of taxes deducted in prior years to the extent they reduced income subject to tax in the year deducted (see section 111). Do not offset current year taxes against tax refunds.
• The amount of any deduction previously taken under section 179A that is subject to recapture. The fund must recapture the benefit of any allowable deduction for qualified clean-fuel vehicle property (or clean-fuel vehicle refueling property) if the property, later, ceases to qualify. See Regulations section 1.179A-1 for details.
• Ordinary income from trade or business activities of a partnership (from Schedule K-1 (Form 1065 or 1065-B)). Do not offset ordinary losses against ordinary income. Instead, include the losses on line 22, Form 1120-RIC. Show the partnership's name, address and EIN on a separate statement attached to this return. If the amount entered is from more than one partnership, identify the amount from each partnership.

Deductions

Limitations on Deductions

Transactions between related taxpayers.   Generally, an accrual basis taxpayer may only deduct business expenses and interest owed to a related party in the year the payment is included in the income of the related party. See sections 163(e)(3), 163(j), and 267 for limitations on deductions for unpaid interest and expenses.

Direct and indirect costs (including taxes) allocable to real or tangible personal property constructed or improved by the taxpayer.   Such costs must be capitalized in accordance with section 263A.

Golden parachute payments.   A portion of the payments made by a fund to key personnel that exceeds their usual compensation may not be deductible. This occurs when the fund has an agreement (golden parachute) with these key employees to pay them these excessive amounts if control of the fund changes. See section 280G.

Business startup expenses.   Business startup expenses must be capitalized unless an election is made to amortize them over a period of 60 months. See section 195 and Regulations section 1.195-1.

Section 265(a)(3) limitation.   If the fund paid exempt-interest dividends during the tax year (including those dividends deemed paid under section 855), no deduction is allowed for that portion of otherwise deductible expenses, which bears the same ratio as the amount of tax-exempt interest income bears to total gross income (including tax-exempt income but excluding capital gain net income).

Net operating loss deduction.   The net operating loss deduction is not allowed.

Passive activity limitations.   Limitations on passive activity losses and credits under section 469 apply to funds that are closely held (as defined in section 469(j)(1)). Funds subject to the passive activity limitations must complete Form 8810, Corporate Passive Activity Loss and Credit Limitations, to compute their allowable passive activity loss and credit.

Reducing certain expenses for which credits are allowable.   For each credit listed below, the fund must reduce the otherwise allowable deductions for expenses used to figure the credit by the amount of the current year credit.

• Work opportunity credit.
• Research credit.
• Enhanced oil recovery credit.
• Disabled access credit.
• Empowerment zone and renewal community employment credit.
• Indian employment credit.
• Employer credit for social security and Medicare taxes paid on certain employee tips.
• Orphan drug credit.
• Welfare-to-work credit.
• New York Liberty Zone business employee credit.

If the fund has any of these credits, be sure to figure each current year credit before figuring the deduction for expenses on which the credit is based.

Line 9-Compensation of Officers

Enter deductible officers' compensation on line 9. Complete Schedule E if total receipts are $500,000 or more. Total receipts are figured by adding: (a) line 8, Part I, (b) net capital gain from line 1, Part II, and (c) line 9a, Form 2438. Do not include compensation deductible elsewhere on the return, such as elective contributions to a section 401(k) cash or deferred arrangement, or amounts contributed under a salary reduction SEP agreement or a SIMPLE IRA plan.

Include only the deductible part of officers' compensation on Schedule E. (See Disallowance of deduction for employee compensation in excess of $1 million below.) Complete Schedule E, columns (a) through (e), for all officers. The fund determines who is an officer under the laws of the state where incorporated.

Disallowance of deduction for employee compensation in excess of $1 million.   Publicly held funds may not deduct compensation to a covered employee to the extent that the compensation exceeds $1 million. Generally, a covered employee is:

• The chief executive officer of the fund (or an individual acting in that capacity) as of the end of the tax year or
• An employee whose total compensation must be reported to shareholders under the Securities Exchange Act of 1934 because the employee is among the four highest compensated officers for that tax year (other than the chief executive officer).

For this purpose, compensation does not include the following:

• Income from certain employee trusts, annuity plans, or pensions.
• Any benefit paid to an employee that is excluded from the employee's income.

The deduction limit does not apply to:

• Commissions based on individual performance;
• Qualified performance-based compensation; and
• Income payable under a written, binding contract in effect on February 17, 1993.

The $1-million limit is reduced by amounts disallowed as excess parachute payments under section 280G.

For details, see section 162(m) and Regulations section 1.162-27.

Line 10-Salaries and Wages

Enter the amount of salaries and wages paid for the tax year, reduced by:

• Any work opportunity credit from Form 5884,
• Any empowerment zone and renewal community employment credit from Form 8844,
• Any Indian employment credit from Form 8845,
• Any welfare-to-work credit from Form 8861, and
• Any New York Liberty Zone business employee credit from Form 8884.

See the instructions for these forms for more information. Do not include salaries and wages deductible elsewhere on the return, such as elective contributions to a section 401(k) cash or deferred arrangement, or amounts contributed under a salary reduction SEP agreement or a SIMPLE IRA plan.

If the fund provided taxable fringe benefits to its employees, such as personal use of a car, do not deduct as wages the amount allocated for depreciation and other expenses claimed on lines 14 and 22.

Line 12-Taxes and Licenses

Enter taxes paid or accrued during the tax year, but do not include the following:

• Federal income taxes (except for the tax imposed on net recognized built-in gain allocable to ordinary income).
• Foreign or U.S. possession income taxes if a foreign tax credit is claimed, or if the fund made an election under section 853.
• Excise taxes imposed under section 4982 on undistributed RIC income.
• Taxes not imposed on the fund.
• Taxes, including state or local sales taxes, that are paid or incurred in connection with an acquisition or disposition of property (these taxes must be treated as a part of the cost of the acquired property or, in the case of a disposition, as a reduction in the amount realized on the disposition).
• Taxes assessed against local benefits that increase the value of the property assessed (such as for paving, etc.).
• Taxes deducted elsewhere on the return.

See section 164(d) for apportionment of taxes on real property between seller and purchaser.

Line 13-Interest

Note:   The deduction for interest is limited when the fund is a policyholder or beneficiary with respect to a life insurance, endowment, or annuity contract issued after June 8, 1997. For details, see section 264(f). Attach a statement showing the computation of the deduction.

The fund must make an interest allocation if the proceeds of a loan were used for more than one purpose (e.g., to purchase a portfolio investment and to acquire an interest in a passive activity). See Temporary Regulations section 1.163-8T for the interest allocation rules.

Do not deduct the following interest:

• Interest on indebtedness incurred or continued to purchase or carry obligations if the interest is wholly exempt from income tax. For exceptions, see section 265(b).
• For cash basis taxpayers, prepaid interest allocable to years following the current tax year. (For example, a cash basis calendar year taxpayer who in 2002 prepaid interest allocable to any period after 2002 can deduct only the amount allocable to 2002).
• Interest and carrying charges on straddles. Generally, these amounts must be capitalized. See section 263(g).

Special rules apply to:

• Interest on which no tax is imposed (see section 163(j)).
• Foregone interest on certain below-market-rate loans (see section 7872).
• Original issue discount on certain high-yield discount obligations (see section 163(e) to figure the disqualified portion).

Line 14-Depreciation

Besides depreciation, include on line 14 the part of the cost that the fund elected to expense under section 179 for certain tangible property placed in service during tax year 2002 or carried over from 2001. See Form 4562, Depreciation and Amortization, and its instructions.

Line 22-Other Deductions

Note:   Do not deduct fines or penalties paid to a government for violating any law.

Attach a schedule, listing by type and amount, all allowable deductions that are not deductible elsewhere on Form 1120-RIC, including amortization of organization expenses. Enter the total of other deductions on this line.

Also include ordinary losses from trade or business activities of a partnership (from Schedule K-1 (Form 1065 or 1065-B)). Do not offset ordinary income against ordinary losses. Instead, include the income on line 7. If the amount entered is from more than one partnership, identify the amount from each partnership.

Generally, a deduction may not be taken for any amount that is allocable to a class of exempt income. See section 265(b) for exceptions.

Charitable contributions.   Enter contributions or gifts actually paid within the tax year to or for the use of charitable and governmental organizations described in section 170(c) and any unused contributions carried over from prior years.

Funds reporting taxable income on the accrual method may elect to treat as paid during the tax year any contributions paid by the 15th day of the 3rd month after the end of the tax year if the contributions were authorized by the board of directors during the tax year. Attach a declaration to the return, signed by an officer, stating that the resolution authorizing the contributions was adopted by the board of directors during the tax year. Also attach a copy of the resolution.

Charitable contributions over the 10% limitation may not be deducted for the tax year but may be carried over to the next 5 tax years.

Substantiation requirements. Generally, no deduction is allowed for any contribution of $250 or more unless the fund gets a written acknowledgment from the donee organization that shows the amount of cash contributed, describes any property contributed, and, either gives a description and a good faith estimate of the value of any goods or services provided in return for the contribution or states that no goods or services were provided in return for the contribution. The acknowledgment must be obtained by the due date (including extensions) of the fund's return, or, if earlier, the date the return is filed. Do not attach the acknowledgment to the tax return, but keep it with the fund's records. These rules apply in addition to the filing requirements for Form 8283, Noncash Charitable Contributions, described below.

For more information on substantiation and recordkeeping requirements, see the regulations under section 170 and Pub. 526, Charitable Contributions.

Contributions to organizations conducting lobbying activities. Contributions made to an organization that conducts lobbying activities are not deductible if:

• The lobbying activities relate to matters of direct financial interest to the donor's trade or business and
• The principal purpose of the contribution was to avoid Federal income tax by obtaining a deduction for activities that would have been nondeductible under the lobbying expense rules if conducted directly by the donor.

Contributions of property other than cash. If the fund contributes property other than cash and claims over a $500 deduction for the property, it must attach a schedule to the return describing the kind of property contributed and the method used to determine its fair market value (FMV). Closely held funds must complete Form 8283 and attach it to their returns. All other funds generally must complete and attach Form 8283 to their returns for contributions of property (other than money) if the total claimed deduction for all property contributed was more than $5,000.

If the fund made a qualified conservation contribution under section 170(h), also include the FMV of the underlying property before and after the donation, as well as the type of legal interest contributed, and describe the conservation purpose benefited by the donation. If a contribution carryover is included, show the amount and how it was determined.

Reduced deduction for contributions of certain property. For a charitable contribution of property, the fund must reduce the contribution by the sum of:

• The ordinary income and short-term capital gain that would have resulted if the property were sold at its FMV, and
• For certain contributions, the long-term capital gain that would have resulted if the property were sold at its FMV.

The reduction for the long-term capital gain applies to:

• Contributions of tangible personal property for use by an exempt organization for a purpose or function unrelated to the basis for its exemption and
• Contributions of any property to or for the use of certain private foundations except for stock for which market quotations are readily available (section 170(e)(5)).

Larger deduction. A larger deduction is allowed for certain contributions of:

• Inventory and other property to certain organizations for use in the care of the ill, needy, or infants (see section 170(e)(3) and Regulations section 1.170A-4A);
• Scientific equipment used for research to institutions of higher learning or to certain scientific research organizations (other than by personal holding companies and service organizations) (see section 170(e)(4)); and
• Computer technology and equipment for educational purposes.

Contributions of computer technology and equipment for educational purposes. A fund may take an increased deduction under section 170(e)(6) for qualified contributions of computer technology or equipment for educational purposes. Computer technology or equipment means computer software, computer or peripheral equipment, and fiber optic cable related to computer use. A contribution is a qualified contribution if:

• It is made to an eligible donee (see below);
• Substantially all the donee property's use is:
  1. Related to the purpose or function of the donee,
  2. For use within the United States, and
  3. For educational purposes.
• The contribution is made not later than 3 years after the date the taxpayer acquired or substantially completed the construction of the property;
• The original use of the property is by the donor or the donee;
• The property is not transferred by the donee for money, services, or other property, except for shipping, transfer, and installation costs;
• The property fits productively into the donee's education plan; and
• The property meets standards, if any, that may be prescribed by future regulations, to assure it meets minimum functionality and suitability for educational purposes.

Eligible donee.   The term eligible donee means:

• An educational organization that normally maintains a regular faculty and curriculum and has a regularly enrolled body of pupils in attendance at the place where its educational activities are regularly conducted,
• A section 501(c)(3) entity organized primarily for purposes of supporting elementary and secondary education, or
• A public library (as described in section 170(e)(6)(B)(i)(lll)).

Exceptions.   The following exceptions apply to the above rules for computer technology and equipment:

• Contributions to private foundations may qualify if the foundation contributes the property to an eligible donee within 30 days after the contribution and notifies the donor of the contribution. For more details, see section 170(e)(6)(C).
• For contributions of property reacquired by the manufacturer of the property, the 3 year period begins on the date that the original construction of the property was substantially completed. Also, the original use of the property may be by someone other than the donor or the donee.

Pension, profit-sharing, etc., plans.   Also include on line 22 the deduction for contributions to qualified pension, profit-sharing, or other funded-deferred compensation plans. Employers who maintain such a plan generally must file one of the forms listed below, even if the plan is not a qualified plan under the Internal Revenue Code. The filing requirement applies even if the fund does not claim a deduction for the current tax year. There are penalties for failure to file these forms on time and for overstating the pension plan deduction. See sections 6652(e) and 6662(f).

Form 5500, Annual Return/Report of Employee Benefit Plan. File this form for a plan that is not a one-participant plan (see below).

Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan. File this form for a plan that only covers the owner (or the owner and his or her spouse) but only if the owner (or the owner and his or her spouse) owns the entire business.

Travel, meals, and entertainment.   Subject to the limitations and restrictions discussed below, the fund can deduct ordinary and necessary travel, meals, and entertainment expenses paid or incurred in its trade or business. Also, special rules apply to deductions for gifts, skybox rentals, luxury water travel, convention expenses, and entertainment tickets. For details, see section 274 and Pub. 463.

Travel. The fund cannot deduct travel expenses of any individual accompanying a corporate officer or employee, including a spouse or dependent of the officer or employee, unless:

• That individual is an employee of the corporation and
• His or her travel is for a bona fide business purpose and would otherwise be deductible by that individual.

Meals and entertainment. Generally, the fund can deduct only 50% of the amount otherwise allowable for meals and entertainment expenses paid or incurred in its trade or business. In addition (subject to exceptions under section 274(k)(2)):

• Meals must not be lavish or extravagant;
• A bona fide business discussion must occur during, immediately before, or immediately after the meal; and
• An employee of the fund must be present at the meal.

See section 274(n)(3) for a special rule that applies to expenses for meals consumed by individuals subject to the hours of service limits of the Department of Transportation.

Membership dues. The fund may deduct amounts paid or incurred for membership dues in civic or public service organizations, professional organizations, business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards. However, no deduction is allowed if a principal purpose of the organization is to entertain, or provide entertainment facilities for, members or their guests. In addition, funds may not deduct membership dues in any club organized for business, pleasure, recreation, or other social purpose.

Entertainment facilities. The fund cannot deduct an expense paid or incurred for a facility (such as a yacht or hunting lodge) used for an activity usually considered entertainment, amusement, or recreation.

Note:   The fund may be able to deduct otherwise nondeductible meals, travel, and entertainment expenses if the amounts are treated as compensation and reported on Form W-2 for an employee or on Form 1099-MISC for an independent contractor.

Deduction for clean-fuel vehicles and certain refueling property.   Section 179A allows a deduction for part of the cost of qualified clean-fuel vehicle property and qualified clean-fuel vehicle refueling property placed in service during the tax year. For more information, see Pub. 535, Business Expenses.

Lobbying expenses.   Generally, lobbying expenses are not deductible. These expenses include:

• Amounts paid or incurred in connection with influencing Federal or state legislation (but not local legislation) or
• Amounts paid or incurred in connection with any communication with certain Federal executive branch officials in an attempt to influence the official actions or positions of the officials. See Regulations section 1.162-29 for the definition of influencing legislation.

Dues and other similar amounts paid to certain tax-exempt organizations may not be deductible. See section 162(e)(3). If certain in-house lobbying expenditures do not exceed $2,000, they are deductible. For information on contributions to charitable organizations that conduct lobbying activities, see the instructions above. For more information on lobbying expenses, see section 162(e).

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