Tax Issues

Tax Issues

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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