Mutual Decisions: Taxes Have Different Effects On Mutual Fund Investors
By Christine Hall
Whether you’re new to mutual funds or a seasoned investor who wants to learn more, you need to have a clear understanding of how distributions from mutual funds are taxed.
Tax law generally treats mutual fund shareholders as if they directly owned a proportionate share of the fund’s portfolio of securities and you must report as income any mutual fund distributions, whether or not they are reinvested. Thus, all dividends and interest from securities in the portfolio, as well as any capital gains from the sales of securities, are taxed to the shareholders.
There are two types of taxable distributions: ordinary dividends and capital gain distributions.
Ordinary Dividends. Distributions of ordinary dividends, which come from the interest and dividends earned by securities in the fund’s portfolio, represent the net earnings of the fund. They are paid out periodically to shareholders. Like the return on any other investment, mutual fund dividend payments decline or rise from year to year, depending on the income earned by the fund in accordance with its investment policy. These dividend payments are considered ordinary income and must be reported on your tax return.
In 2016 (same as 2015), dividend income that falls in the highest tax bracket (39.6 percent) is taxed at 20 percent. For the middle tax brackets (25-35 percent) the dividend tax rate is 15 percent, and for the two lower ordinary income tax brackets of 10 percent and 15 percent, the dividend tax rate is zero.
Qualified dividends. Qualified dividends are the ordinary dividends subject to the same 0 or 15 percent maximum tax rate that applies to net capital gain. They are subject to the 15 percent rate if the regular tax rate that would apply is 25 percent or higher; however the highest tax bracket, 39.6 percent, is taxed at a 20 percent rate. If the regular tax rate that would apply is lower than 25 percent, qualified dividends are subject to the 0 percent rate.
Capital gain distributions. When gains from the fund’s sales of securities exceed losses, they are distributed to shareholders. As with ordinary dividends, these capital gain distributions vary in amount from year to year. They are treated as long-term capital gain, regardless of how long you have owned your fund shares. A mutual fund owner may also have capital gains from selling mutual fund shares.
Capital gains rates. The beneficial long-term capital gains rates on sales of mutual fund shares apply only to profits on shares held more than a year before sale. Profit on shares held a year or less before sale is considered ordinary income, but capital gain distributions are long-term regardless of the length of time held before the distribution.
Long term capital gains are taxed at 20 percent (39.6 percent tax bracket), 15 percent for the middle tax brackets (25 percent, 28 percent, 33 percent, and 35 percent), and 0 percent for the 10 percent and 15 percent tax brackets.
Medicare Tax. Starting with tax year 2013, an additional Medicare tax of 3.8 percent is applied to net investment income for individuals with modified adjusted gross income above $200,000 (single filers) and $250,000 (joint filers).
At tax time, your mutual fund will send you a Form 1099-DIV, which tells you what earnings to report on your income tax return, and how much of it is qualified dividends. It is of the utmost importance to provide the full 1099 to your tax preparer to ensure the proper tax reporting of your investment income.
Hall, Murphy & Schuyler, PC is a full-service public accounting firm. They have a staff of experienced professionals that stand ready to meet all of your accounting, tax and general business needs. For a complimentary consultation, call 706-855-7733 or email at cmh@HMandScpas.com.