Tough Tax Year Ahead

December 3, 2007

SmartMoney reports that mutual fund investors are in for a tough April 15th. Taxes paid by mutual fund investors, muted for years by the big losses of the early 2000s, are back with a vengeance:

Fund industry experts are predicting a double whammy this year that we haven't seen since the tech bubble burst. Not only will investors be staring at flat or dismal returns, but they'll also be faced with paying taxes on big capital gains distributions from the well-performing funds they held before the recent turmoil began. Lipper senior research analyst Tom Roseen estimates that investors may pay 20% to 30% more to the federal government than the $24 billion they shelled out last year. That means the typical investor, depending on how much they've saved in certain funds and what type of an account that money is in, could face a tax bill of thousands of dollars. 'We could easily hit the highest tab investors have ever seen,' says Roseen."

By law, funds have to distribute any taxable gains from investing to shareholders each year.

Your fund has profits and losses much like your own portfolio does. Funds can have losses from bad investments, gains in the form of short term or long term capital gains, ordinary income, and now, low tax dividend income.

Each year the fund accountants figure out how much income there is of each type. The tax liability is then passed on to the shareholders in the form of a dividend (the tax rate for each depends on the shareholder), which is why none of this matters in a tax deferred account like an IRA or 401(k).

Most of these fund distributions are made in December and many fund companies give estimates of these distributions on their websites in late November and early December, which can help existing and potential investors avoid some taxable gains.


See also:

Capital Gains Questions?

Tougher Tax Times Ahead for Mutual Fund Investors

How Mutual Funds Work - Capital Gains

Six Mutual Fund Tax Tips