Mutual funds offer individual investors two primary advantages. With a single investment you get professional management of your money and an instantly diversified portfolio of securities. But mutual fund ownership includes a number of expenses, some of which are obvious, such as loads and commissions, and others not so obvious, like the fund's management fees. Those expenses can cut into your profits, and to make matters worse, they are usually not tax-deductible.
When it comes to choosing a mutual fund, one primary concern is how much it costs to buy or sell. Loaded funds typically include a sales charge that is built into the price you pay when you buy your shares. Some funds, called back-end funds, might not charge you up front, but charge you if you sell your shares within a set time frame. Some funds, commonly referred to as no-load funds, don't have a sales charge at all. Mutual fund loads, whether front-end or back-end, are not tax-deductible.
Just because a mutual fund doesn't have a load, doesn't mean you get off scot-free. Some no-load funds have a purchase fee or a redemption fee. These fees are different from front-end or back-end loads because they're paid to the fund rather than to a sales agent. The difference probably doesn't mean much to you, since it's still money out of your pocket, and you still can't deduct those fees from your federal income taxes.
External mutual fund costs, such as commissions, sales charges, loads and purchase fees, might not be tax-deductible, but they are still important for tax purposes. You can add those costs to your mutual fund's purchase price, which increases your cost basis. This won't provide any immediate tax relief, but it will reduce the amount of any capital gains tax you might incur when you sell your fund shares in the future.
Deductible Investment Expenses
Some of your expenses associated with buying mutual fund shares are tax-deductible under certain circumstances. For example, if you pay an investment adviser for managing your portfolio, you can include those costs with your other miscellaneous deductions, such as your employee business expenses. This might not give you much tax relief, unless you have a sizable portfolio, since these expenses are limited by the IRS's 2-percent rule: You can only write off the amount that exceeds 2 percent of your adjusted gross income.
- Internal Revenue Service: Publication 17, Other Expenses (Line 23)
- Investment News: Which Portfolio Fees Are Tax Deductible?
- Christian Science Monitor: Mutual Fund Sales Commissions: Are They Tax-Deductible?
- Internal Revenue Service: Publication 550, Publicly-Offered Mutual Funds.
- Investment Company Institute: What is a Mutual Fund Share’s Cost Basis?
- Securities and Exchange Commission: Mutual Fund Fees and Expenses
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.