When do I pay taxes on my mutual fund?

Question

I just opened a mutual fund account for long term savings and plan to invest around $150 a month. I will not sell any shares or take any money out of this account for about 10 years. How do I handle taxes with this? Do I just claim the amount of earnings each year when I file my taxes, or does this get claimed when I sell?

Answer 1

If your mutual fund is in a regular taxable custodial account (not an IRA and not an annuity), then you will have to pay taxes in the following ways:

1) Any dividends or interest that the stocks or bonds pay that year will be passed on to you. You will have to pay taxes on them in the year they were distributed. For example, any dividends distributed this year, you will need to report on your 2007 tax return when you file.

2) Any capital gains that the manager incurs while selling shares WITHIN THE FUND are passed on to you. Just like above, you will have to pay taxes on them the year they are distributed to you. For example, if your fund manager sells some apple stock to purchase stock in another company, she will pass the capital gains onto you and you will pay a tax when you file your 2007 taxes.

3) Any capital gain YOU MAKE by selling mutual fund shares are taxed in the year that you sell.

So, in summary, #1 and #2 are taxed every year, while #3 is only taxed in the year(s) that you sell shares. You cannot control #1 and #2. You only have direct control over #3.

Capital gains are taxed at 10 or15% if it is a long-term gain. Short-term capital gains are taxed like income, at your tax bracket.

Qualified dividends from U.S. stocks are taxed at 10 or 15% rate. Interest from bonds is taxed as income, at your tax bracket rate.

Do not worry about how to report #1 and #2 on your tax return, because your mutual fund company is required by law to send you a tax statement in January each year. It will print out exactly what you need to put on your tax form. It will tell you what numbers to stick where on your tax return.

The important thing to note is that you DO pay taxes each and every year you hold mutual funds in a taxable account, EVEN IF you do not sell your mutual fund shares. Then, when you sell mutual fund shares, you will have to calculate a capital gains tax on those shares IN ADDITION TO any annual taxable events.

Here is my advise: If you have not sold any shares, then your taxes will be relatively simple. Just use the form that your mutual fund company sends you to fill out your taxes. However, once you decide to sell shares, you may want to consider having an accountant do your taxes for that particular year. The accountant can help you figure out how to pay capital gains on the mutual fund shares, because the IRS allows you three options to report capital gains.

Figuring out capital gains for 10 years of mutual fund shares might be tricky. Every time you buy shares (or dividends are reinvested in new shares) at different prices, a new "tax lot" is formed and a new capital gain will have to be calculated when you eventually share.

Note once again ... there are two different types of capital gains. One type are the capital gains created by the fund manager, which are beyond your control. These will be reported to you by your mutual fund company and the capital gains will already be determined. This is easy to report on your taxes. The other type is the capital gains YOU MAKE when you sell mutual fund shares. This is different from the first type. This capital gain is more complex to calculate, and you might want the help of an accountant.

For more info on mutual funds, download my free book at http://www.invest-for-retirement.com and go straight to the chapter on "The Anatomy of Mutual Funds". Don't be scared away from investing because of taxes. After you file your 2007 taxes you will see that it is not too complicated. Besides, if taxes ever become too complex, go get an accountant.

Answer 2

I was looking for this info last week - I found the following. The mutual fund manager must send the investor a tax information statement so the investor can declare taxes. The investor must account for all capital gains or loses and dividends even if the dividends and capital gains are reinvested into the mutual fund. When mutual funds shares are sold/redeemed the mutual fund manager should aid the investor in determining the purchase bases for the shares sold/redeemed. Recent federal tax codes have modified the treatment of dividends and capital gains depending on the investor's income level and tax bracket.

Answer 3

The mutual fund will often pay dividends and capital gains each year. Whether you take these amounts in cash or reinvest them to buy more shares, they are taxable each year. Your mutual fund will send you a 1099-div each year before Mar 1. Keep detailed records of your cost of shares (money you invested directly and funds invested by your mutual fund company out of the dividends paid). When you sell the shares, your cost basis is the amount you directly invested PLUS the amount that was reinvested. Your mutual fund company should provide you with your cost basis when you sell shares. If they don't, and you do not have accurate cost basis records, you could end up paying tax on the reinvested earnings twice...each year and when you sell.

Answer 4

You will get a 1099 form at the end of the year from your broker shwoing the capital gains and dividends that you owe taxes on. You report it on Schedule D with your income taxes. Unless the mutual fund is in a tax-sheltered account such as an IRA, you owe taxes on the dividends and captial gains recieved each year, whether you reinvest them in the fund or take them out. You will owe capital gains taxes on the fund shares when you sell it.

Answer 5

You pay taxes when you sell it.
You may also end up paying taxes on dividends or realized capital gains that the fund pays out, but they'll send you a 1099-DIV form to handle this.
(With realized capital gains, the company sometimes cashes stuff out for you.)
Quick note for taxes: Make sure to note any dividends so you can better compute the true cost basis, otherwise you may end up overpaying the true capital gain.

Answer 6

At the end of the tax year your fund provider will send you a statement showing dividends and capital gains the fund made over the prior tax year. This must be reported as taxable income unless the fund is tax exempt.

Answer 7

Every year, the fund will send you a statement, in which they will detail the amount of taxable income and capital gains that the fund has received on your behalf. You will then add those figures to your tax returns.

Answer 8

Nothing happens tax wise until you sell. You don't have to make estimated tax payments or anything. If your fund increases in value you have an "unrealized gain". The gain isn't "realized" until you liquidate the account (sell the shares).