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Tax Issues
“Mutual fund investors may be able to save especially
large amounts of taxes by focusing on the details.”
The Wall Street Journal's
-Lifetime Guide To Money
You can save money on mutual fund taxes particularly if
you are highly motivated and keep careful records. The following
will familiarize you with the taxes associated with mutual
funds:
Dividends: these are proceeds paid out periodically
by stock or bond mutual funds. Many investors choose to reinvest
dividends automatically. Whether you reinvest or not, you
are still liable for annual taxes on dividends, which are
taxed at your ordinary income tax rate.
Capital Gains: this is the money you earn whenever
you or your mutual fund manager sells fund shares or fund
holdings at a profit. The short-term capital gains top rate--for
shares or securities held for less than one year--is
taxed at your ordinary income rate, which ranges from 10% to 35%. The long-term
capital gains top rate--for shares or securities held for
more than one year can range from 5% to 28%
at the federal level plus applicable
state taxes. Check www.irs.gov for updated tax information.
To calculate your capital gains, you may choose from one
of the following methods:
- First In First Out (FIFO): this method assumes that the
first shares you sold came from the first shares you purchased,
so you use the share price from the oldest purchase date.
- Specific Shares Method: this method requires that you
“adequately identify” which shares you want to
sell by specifying their original purchase date at the time
you sell them. You must also receive a written confirmation
of the transaction from your broker.
- Average Cost Per Share, Single Category Method: with this
method, you divide the total cost of all your shares by
the total number of shares owned to arrive at an average
cost per share.
- Average Cost Per Share, Double Category Method: this method
requires two steps. First, you separate the shares into
short-term (owned less than a year) and long-term (owned
more than a year) categories. Then you determine the average
cost per share in each category. After that, you must specify
from which category you want your shares sold, and then
follow the requirements of the Specific Shares Method.
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