Mutual fund distributions – Part 1
Joel Dresang: Ron, we want to talk about capital gains and investors. Mostly, we want to talk about mutual funds, but let’s start by talking about capital gains. What is that?
Ron Hansen: When you sell a capital asset for a price greater than your cost, you will realize a capital gain, and it has to be reported on your tax return.
Joel: But within mutual funds, if the mutual fund sells part of its investments and realizes a capital gain, that also is distributed to the mutual fund holder.
Ron: By law, mutual funds have to distribute all of the capital gains that they realize in the portfolios on your behalf. You get a 1099 showing the amount that’s involved. You have to report it on your tax return.
Joel: And my understanding is that we’re going to be seeing more of that because of how the stock market’s been going up.
Ron: Correct. In the years prior to 2013, many mutual funds had losses that they were carrying forward from the downturn that started in 2007. Most of that has been used up. And now, when they sell something for a gain, they have got those gains as a positive number that they have to report to you on your 1099.
Joel: And the gains are considered short-term or long-term. Short-term is if the mutual fund owned it for less than a year, and long-term is if it’s more than a year. How are those treated differently?
Ron: Short-term gains will become fully taxable income. Long-term gains will get a preferred tax rate.
Joel: What kind of a range are we looking at?
Ron: Depending upon the income tax bracket that you’re in, and let’s start with the two low brackets – 10% and 15% – the end result of the dollars reported you will result in no additional income tax. If you move up to the next bracket – 25% – you start with 15%. And eventually, if you’re in the highest bracket, it could become 20% that you pay as a tax rate.
Joel: And then there’s an extra 3.8%?
Ron: Correct. And that’s the top three brackets.
Joel: What about if you reinvest these distributions that the mutual funds make to you? Are you still taxed for them?
Ron: Regardless of how you take that distribution, cash in the form of a check or push it back into your account, it’s going to be taxable income.
Joel: And we don’t really have to worry about the capital gains if the mutual funds are owned in accounts like IRAs and 401(k)s that are treated differently for taxes?
Ron: Correct. Even though they will show the transactions on your statements, it will all remain tax-deferred until you draw money from your accounts sometime in the future, and then it will be fully taxable at that point.
More information Mutual fund distributions – Part 2 IRS Publication 550, Investment Income and Expenses
Joel: I also want to add that we’ll have links to more information at the bottom of this video and also on our website.
FAQ About Taxation for Mutual Fund Investors, Investment Company Institute
Ron Hansen is vice president and investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May
(initially posted April 3, 2014)