How are mutual funds taxed?

Posted In: Financial Planning General Investment

Whenever a mutual fund company passes earnings and other payouts to shareholders, they are known as a distribution.  The tax treatment of these distributions varies depending on the type of distribution.  If you hold shares in a taxable account, you are required to pay taxes on mutual fund distributions, whether the distributions are paid out in cash or reinvested in additional shares. The funds report distributions to shareholders on IRS Form 1099-DIV after the end of each calendar year. In addition, if you sell shares in a mutual fund, you must report the transaction on your tax return and pay tax on any gains. For federal tax purposes, ordinary income is generally taxed at higher rates than qualified dividends and long-term capital gains.

 

The chart below illustrates how each type of mutual fund transaction is taxed:

 

Type of Distribution

Definition

Federal income tax treatment

Long-term capital gains

Net gains from the sale of shares held for more than one year; may include some distributions received from investments held by the fund

Subject to the capital gains rates, usually lower than the ordinary income tax rates

Short-term capital gains

Net gains from the sale of shares held for one year or less

May be treated as ordinary dividends, thus taxable at ordinary income tax rates

Qualified dividends

Dividends from common stock of domestic corporations and qualifying foreign corporations

Normally taxed as long-term capital gains (subject to certain holding period and hedging restrictions)

Ordinary or non-qualified dividends

Investment income earned by the fund from interest and non-qualified dividends minus expenses; often used as a blanket term that includes all taxable income except long-term capital gains.

Taxable at ordinary income tax rates

Tax-exempt interest

Some or all interest on certain bonds, usually state or local municipal bonds, designated as tax-exempt

Not taxable for federal tax purposes; may be subject to state and/or local taxes, depending on your resident state and the type of bonds purchased

Taxable interest

Interest on fixed-income securities

Taxable at ordinary income tax rates

Federal interest

Interest on federal debt instruments

Taxable at ordinary federal income tax rates, but exempt from state income tax

Required distributions

Non-investment income required to be distributed by the fund (such as foreign currency gains)

Taxed as ordinary income

Return of capital

A portion of your invested principal returned to you

Not taxable

 

 

Ambassador Advisors is a Registered Investment Advisor. Securities offered through American Portfolios Financial Services, Inc. of Holbrook, NY, 631-439-4600 (APFS), member FINRA, SIPC. Investment Advisory Services offered through Ambassador Advisors, LLC. Ambassador Advisors is not owned or operated by APFS. To determine which college saving option is right for you, please consult your tax and accounting advisors. Neither APFS nor its affiliates or financial professionals provide tax, legal or accounting advice. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about municipal fund securities, please obtain an offering statement and read it carefully before you invest. Investments in 529 college savings plans are neither FDIC insured nor guaranteed and may lose value.

Any opinions expressed in this forum are not the opinion or view of Ambassador Advisors or American Portfolios Financial Services, Inc. (APFS). They have not been reviewed by either firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors.

This material is for informational purposes only. Neither APFS nor its Representatives provide tax, legal or accounting advice. Please consult your own tax, legal or accounting professional before making any decisions.

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