Regulated Investment Company (RIC) 90% Income Test
The Formal Definition
A statutory tax qualification mandate under Subchapter M of the US Internal Revenue Code (IRC Section 851(b)(2)) requiring registered investment companies (mutual funds, ETFs, and BDCs) to derive at least 90% of their gross annual income from qualifying passive investment sources (dividends, interest, and capital gains on securities).
Qualifying Gross Income Ratio = (Dividends + Interest + Capital Gains from Securities) / Total Fund Gross Income ≥ 90.0%
Cole Barrett's Reality Check
The Unvarnished Bottom Line"Subchapter M is the legal engine of the ETF industry. It exempts funds from paying corporate income taxes, passing 100% of dividends and gains straight through to shareholders. But to keep that pass-through status, the fund must pass the 90% test. If an ETF makes more than 10% of its income from non-qualifying sources like physical commodities or direct business revenue, it loses its status and gets taxed twice as a regular corporation."
Interactive Simulator: Test the Math
Real-World Example: Scenario Breakdown
Examining the real numbers for: Due diligence audit of an innovative multi-asset exchange-traded fund generating $10,000,000 in gross annual income
| Execution Metric | Subchapter M Compliant ETF Sponsor | Non-Compliant Boutique Fund |
|---|---|---|
| Fee / Rate | 0.15% fund expense ratio | 1.25% fund management fee |
| Spread / Buffer | Structured commodity exposure via an offshore Cayman subsidiary (capped at 25% of assets) to ensure 95% of income qualified | Derived 15% of annual fund income from direct physical commodity trading and non-qualifying commercial loan fees |
| Execution / Status | Met the Section 851(b)(2) 90% income test; distributed all net investment income cleanly as pass-through dividends | Breached the statutory 90% qualifying income test; IRS revoked the fund's Regulated Investment Company status |
| Total Cost / Result | Preserved pass-through tax status through structured compliance | Suffered entity-level double taxation from breaching RIC income rules |
How Brokers Weaponize This Term
When analyzing alternative, commodity, or private credit ETFs, review their legal structure in the prospectus. Funds utilizing offshore Cayman subsidiaries (typically capped at 25% of assets) do so specifically to turn non-qualifying commodity income into qualifying dividend distributions to pass the 90% test.
Broker Evaluation Matrix
Cole Approves
Charles Schwab: Provides institutional fund screening that categorizes fund structures, prospectus documentation, and Subchapter M pass-through tax status.
Read Audit →Cole Flags / Avoids
Unregistered Alternative Investment Syndicates: Markets collective investment pools that fail Subchapter M criteria, subjecting investors to corporate-level double taxation.
View Trap Details →Frequently Asked Questions
What happens if a mutual fund fails the 90% income test?
Under Section 851(d), if the failure is due to reasonable cause, the fund can pay a statutory penalty tax to preserve its status; otherwise, it is taxed as an ordinary corporation on all income and gains.
Why don't physical commodity gains qualify as RIC income?
Because IRC Section 851 explicitly requires qualifying income to be derived from securities, currencies, or options/futures on securities. Direct gains from buying and selling physical commodities like gold or oil are non-qualifying.