A Guide to Mutual Funds and Taxes

A Guide to Mutual Funds and Taxes

In the United States, mutual funds are among the most popular financial tools for investors. Money is combined into a pool from investors to invest in stocks, bonds, and other security assets to create a diversified portfolio. Many small or independent investors utilize mutual funds because they are affordable and instantly enlarge their portfolio.

Mutual fund portfolios are managed by professional fund managers who determine what types of bonds, stocks, and other securities to buy and sell. Investors only own the mutual fund’s shares and pay an operating fee to keep the mutual fund running.

Mutual Funds and Taxes: Tips to Consider

When it comes to mutual funds and taxes, investors typically have lots of questions. The way mutual funds are taxed depends on the type of investments in the mutual fund portfolio.

Let’s take a look at how and when investors pay taxes on their mutual funds.

Distributions You Receive

As an investor, the distributions you receive from the mutual fund must be declared on your yearly taxes as investment income. It’s important to note that determining how much income tax you pay on each dollar of the distribution dwindles to:

  • The type of distribution received
  • The length of investment holding
  • The type of investment

When You Get Dividends or Interest

Mutual funds are required to give almost all of the proceeds from investments to shareholders. As a result, bonds or stocks that generate dividends or interest must be distributed to the fund’s shareholders.

Shareholders can either choose to have their dividends distributed back to them or reinvested back into the fund. If they decide to have their dividends reinvested, the IRS will consider this as taxable income. Similarly, bonds might receive interest payments where a shareholder’s portion of that interest may be regarded as taxable income, even if it is reinvested. Some bonds, however, may be tax-free, such as municipal bonds.

Fund Managers Generate Capital Gains

When a fund manager sells shares of bonds, stocks, or other securities in the mutual fund, a capital gain occurs. The IRS requires fund managers to distribute these gains to investors once a year and considers gains as taxable income even if they’re reinvested.

As an investor, you’ll need an IRS Form 1099-DIV to report your capital gain on your tax return. Depending on the length of time the mutual fund held onto the investment will determine how much your capital gains are taxed.

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Tobin & Collins is a regional CPA and consulting firm providing accounting, tax, and business support services to clients in the New Jersey and New York metropolitan area. Our comprehensive approach to financial and estate planning provides you with a secure future. Contact us today!

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