Tax Consequences of Mutual Fund Profits

You can profit in three ways when you own a mutual fund: through any increase in the net asset value (NAV) of the fund shares; through dividends; and through capital gains. Each of these kinds of profit has a potential impact on the taxes you have to pay. For most investors, tax considerations are not worthy of top ranking on the list of concerns that may affect decisions about buying or selling a mutual fund. Most people are wise to buy and sell mutual funds based on their changing financial goals and their perceptions of the investment markets and the overall economy rather than worrying too much about the relatively small tax consequences of their decisions. However, if you’re in a higher tax bracket (31% to 39.6%), you may want to take the tax implications of your mutual fund investment decisions more seriously. Here are the things you need to know.
At least annually, a mutual fund must distribute to investors the dividends and capital gains that the fund’s portfolio has generated over the course of the year. As Dividends are a portion of the profits generated by a company and shared with those who own stock in the company, and capital gains represent the difference between the price at which you purchased a security and the higher price at which you sold it — the profits.
Bond funds usually distribute the income received from their investments in the form of a monthly dividend. Stock (equity) funds and balanced funds, which hold both stocks and bonds, may distribute dividends quarterly, annually, or semiannually. Capital gains are distributed once a year. Around the end of the calendar year, the mutual fund company sends you a 1099-DIV form detailing the taxable distributions that you received during the year. You use this information when preparing your income tax return for submission by the following April 15.