With mutual funds, unfortunately, you have to pay tax each year on the capital gains and dividends that the fund distributes to each of its shareholders. You also have to pay taxes on your own gains when you sell shares — another reason for a long-term buy-and-hold strategy. The exceptions are funds that invest in U.S. securities. You still have to pay federal income tax on any gains, but you’re free of state and local tax in most situations.
Although some people believe that municipal bond funds are free of federal income tax, that’s only true of municipal bond investments themselves. You pay taxes on capital gains on any profits that a municipal fund makes from selling bonds.
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