Tax planning and compliance for investors
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By Kaye A. Thomas
Updated February 2, 2008
Top page of our guide to tax rules for mutual fund investors.
Mutual funds provide investors with a way to acquire diversified investment holdings and professional management with a relatively small investment. The special tax treatment of mutual funds is designed in part to provide their investors with many of the same tax benefits they would have if they directly owned the stocks and bonds that are held by the fund.
But the tax treatment of mutual funds is somewhat different — and more complicated — than the tax treatment of other stocks. This is true for mutual fund dividends, and it's also true when you sell mutual fund shares. These tax rules can work to your benefit, so it's worth a little effort to learn them. This guide is divided into three sections:
Mutual Funds 101
This page provides an introduction to mutual funds and a brief description of the tax issues that are covered in more detail elsewhere.
Mutual Funds and Retirement Savings
Most of the rules in this Mutual Fund Tax Guide don't apply if you hold a mutual fund investment inside a retirement plan. This page explains tax considerations that apply in this case.
Mutual Fund Dividends
Mutual funds can pay four different types of dividends and make two different types of allocations. Here's the starting point for learning to deal with all these items.
We start with the easy one: how to handle ordinary dividends from mutual funds.
Capital Gain Distributions
Mutual funds that pay capital gain dividends can "pass through" the special tax rates on long-term capital gains. But short-term capital gains pass through as ordinary income.
Exempt Interest Dividends
Mutual funds that receive tax-exempt interest can pass that along to you as tax-exempt income.
Federal Interest Dividends
Mutual funds that receive interest on federal obligations may be able to pass that along to you as income that's exempt from state income tax, even though it's subject to federal income tax.
Some mutual funds make distributions that aren't considered dividends, so they aren't taxable. These distributions affect the basis of your mutual fund shares.
Capital Gain Allocations
Mutual funds can also allocate capital gains to their shareholders without actually paying them out. The surprising result: you report income you never received, and you get credit for tax you never paid. You also get a basis adjustment.
Foreign Tax Paid
Your mutual fund may pay some foreign tax — and report that item to you. This page explains how to use that item to reduce your income tax.
Selling Mutual Fund Shares
This page begins the explanation of how to handle sales of mutual fund shares.
Basis of Particular Shares
How to determine your basis in particular mutual fund shares.
Single-Category Averaging Method
This is the simplest averaging method, but also the least flexible.
Double-Category Averaging Method
This method is a little more difficult than the single-category method, but provides more flexibility when you sell your shares.
Short-Term Capital Losses
There's a rule that requires special treatment for certain short-term capital losses from sales of mutual fund shares.
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