Mutual Fund Taxation: How To Cut The Tax Bite

Basic knowledge of mutual fund taxation can help you cut the tax bite on your mutual fund investments. For example, you must generally report any mutual fund distributions as income, whether or not they are reinvested, because the tax law treats mutual fund shareholders as if they directly own a proportionate share of the fund's portfolio of securities. So, total dividends & interest from securities in the portfolio and capital gains from the sales of securities are charged to shareholders.

Taxable Distributions

There are two types of taxable distributions - first is 'ordinary dividends,' and the other is 'capital gain distributions':

1. Ordinary Dividends

Distributions of ordinary dividends come from the interest and dividends earned by securities in the fund's portfolio. It represents the fund's net earnings. They are paid out regularly to shareholders. Like the return on other investments, mutual fund dividend payments decline or rise from year to year, depending on the fund's income following its investment policy. These dividend payments are examined ordinary income and must be reported on your tax return.

Qualified dividends are ordinary dividends subject to the same tax rates that apply to net long-term capital gains. Dividends from mutual funds qualify where a mutual fund receives qualified dividends and distributes the required proportions thereof. Dividends from foreign corporations are qualified where their stock or ADRs are traded on U.S. exchanges or with IRS approval where U.S. tax treaties cover the dividends.

2. Capital gain distributions

When gains from the fund's sales of securities exceed losses, they distribute it to shareholders. As with ordinary dividends, these capital gain distributions vary in amount from year to year. They are treated as long-term capital gain, regardless of how long you have owned your fund shares. A mutual fund owner may also have capital gains from selling mutual fund shares.

Consult the Professionals

Reducing taxes on your mutual funds is one of the best ways to save money while increasing your net investment returns.  

We at Royal West Agency understand your financial objectives. We have experienced financial experts who can help you build greater financial security and explore what financial solutions are best for you.