Taxing Burden on Your Year-End Mutual Fund Statement?
Dec. 5 -- Losing money and owing money?
Many investors may find themselves in exactly that seemingly unfair situation as the year draws to an end. With the average stock mutual fund down a negative 22.2 percent year to date, investors could be facing losses and receiving distributed capital gains on which they'll have to pay taxes.
Because mutual funds are typically a long-term investment, investors erroneously believe they do not have to pay taxes until they sell their fund shares. Unfortunately, this is not the case. You can actually suffer a loss in your investment and owe capital gains taxes at the same time.
In the wake of significant market volatility this year, many fund managers have had to raise cash by selling their most liquid and often times best performing issues to cover substantial investor redemptions. When your fund manager's individual stock and bond sales lead to more profits than losses, the fund is required to "distribute" those excess gains to you thereby leaving you with a tax bill.
Tax Deferred vs. Taxable Accounts
If your fund is held within a tax-deferred account such as a 401(k) or an individual retirement account, or IRA, you will not owe any taxes until you withdraw your money. But, if you own a fund in a regular or taxable account, you generally have to pay at least 20 percent in taxes on the fund's realized gains.
Even if you do not take the distribution as cash and instead reinvest the dividends to buy more fund shares, the Internal Revenue Service will still come knocking.
Gains that are unrealized when the fund's securities appreciate but are not sold appear on paper only. They are not taxed until they are "realized" and distributed to you, the shareholder.
It is essential you know and understand a fund's record date before opening a new account. If you own shares on or before that date, you will receive the scheduled distribution.
For a new shareholder, this can be a less than favorable situation unless you enjoy paying someone else's taxes. More specifically, when purchasing shares prior to the record date, you will pay taxes on all capital gains incurred prior to your ownership, regardless of how long you have owned the fund.
Related Stories
ABC News Live