Mutual funds are popular in part because they simplify the investment process. Rather than having to research individual securities, you can buy one mutual fund and instantly own shares in a multitude of stocks, bonds or other investments. When it comes to taxation, however, mutual funds can be complicated. Funds must pay out income and gains to shareholders. At tax time, you might have plenty of information you have to report on your tax return.
Not all mutual funds pay interest. However, if your fund does earn interest, it has to pass it along to you. This isn't necessarily a bad thing -- after all, if you own a mutual fund that pays interest you probably bought it for that very reason. However, you will have to report that interest to the Internal Revenue Service. Your fund company will send you a Form 1099-INT at the end of the year showing how much money you were paid. You'll have to transfer that information from your 1099-INT to your Form 1040, 1040A or 1040EZ when you file your taxes, following the instructions given on the appropriate forms. Your interest income will be considered regular income, so you'll pay tax on it at the same rate as your salary or wages.
Dividends are income payments that are somewhat similar to interest payments. However, dividends represent a distribution of corporate profits and are earned through investments in certain stocks. Dividends are typically taxed at ordinary income rates, the same as interest payments. However, certain dividends are designated as qualified dividends, which results in taxation at a lower rate. Any fund that sends you a dividend payment will provide a Form 1099-DIV showing the amount and type of dividends you received. You'll have to report these payments when you file your taxes. To estimate what you'll owe, multiply your regular dividends by your ordinary tax rate, and your qualified dividends by the capital gains tax rate.
Gains and Losses
Selling a mutual fund can result in some higher mathematics on your part. While you'll receive information on Form 1099-B showing the particulars of your trades, you'll still have to segregate that information properly on your tax forms. The Internal Revenue Service will expect you to divide your buys and sells into short-term and long-term trades, with long-term referring to those held for longer than one year. The reason for this division is that the tax rates differ. You'll pay your ordinary income rate on your short-term gains, but you'll pay the lower capital gains rate on your long-term gains. For 2013, this rate tops out at 20 percent.
Capital Gains Distributions
Even if you never sell your mutual fund, you might still be responsible for capital gains taxes. If your fund earns any profits from buying or selling investments, it will pay those gains out to shareholders. Just as if you earned the profits from your trading, you'll have to report the gains to the IRS. Your fund company will provide the requisite information on Form 1099-DIV. Short-term gains will be included as ordinary dividends, while long-term gains have their own line on the form. As with your own gains, you can compute the tax you owe by applying your ordinary income tax rate to the short-term gains, and the appropriate capital gains tax rate to your long-term gains.
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- How to Put a Statement Together for Income
- Are Individual Stock Market Gains Taxable?
- How to Estimate the Annual Income From a Mutual Fund
- How to Change a Dividend Reinvestment
- How to Handle Reinvested Dividends on Schedule D