Tax Planning and Mutual Funds
- When you sell a mutual fund that you hold in a taxable account, it often triggers a taxable event. Just as you do with a stock trade, you must keep track of capital gains and losses you incur when you buy and subsequently sell a mutual fund. As of January 2011, the IRS allows investors to offset capital gains with up to $3,000 worth of capital losses. If you have no losses, you must report all capital gains to the IRS and pay appropriate taxes on them.
- Mutual fund managers buy and sell stocks and other investments inside of their fund they run. This impacts a fund's shareholders. When a mutual fund sells a stock, for example, at a gain, it produces a capital gain, part of which gets distributed to the fund's shareholders. Look at a fund's prospectus or a detailed quote at sites such as Morningstar or Yahoo! or Google Finance and look for the fund's turnover rate. This percentage represents the portion of a fund's holdings that change annually. If a fund's turnover rate equals 50 percent, half of its holdings change every year. A turnover rate of 100 percent or higher indicates that the fund holds investments, on average, for less than a year.
- Each year, mutual funds pay out distributions to shareholders. These earnings come in the form of capital gains, dividends and interest. The portion of the distribution you receive is commensurate with the number of shares of the fund you own. You must report all distributions to the IRS and pay taxes on them. Mutual fund prospectuses outline mutual fund performance after taking into account the impact of taxable distributions.
- You don't always have to pay taxes when you sell a mutual fund for a gain or receive a distribution. If you hold a mutual fund in a tax-deferred account, such as a workplace retirement plan or individual retirement account, you do not have to report these earnings to the IRS. Instead, you'll settle up with Uncle Sam tax-wise, if necessary, when you take distributions from the account that holds your funds.
