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Mutual fund taxation

Taxes are an important consideration for mutual fund investing. There are three ways in which a mutual fund can generate income taxes for you if you hold fund shares in a non tax-qualified account.

  1. Income distributions. Income is generated by a mutual fund from the dividends and interest it receives on its investments. Operating expenses are then subtracted from these earnings, and the remaining profit is distributed to you and other shareholders in the form of dividends.

  2. Capital gains distributions. Capital gains are generated by a mutual fund through the selling of investments within the portfolio. If net long-term capital gain exceeds net short-term capital loss, the fund has a net capital gain. This net capital gain will be distributed to you and other shareholders in the form of a capital gains distribution.

    A capital gains distribution you receive from a mutual fund will be taxed at the long-term capital gains tax rates even if you held the fund shares for one year or less. If the fund has a net short-term capital gain, this gain is distributed to you and other shareholders as an ordinary dividend rather than a capital gains distribution. Net capital losses are not distributed to you; rather, the fund carries the losses forward to future years to offset future capital gains of the fund.

  3. Sales or exchanges of shares. Sales or exchanges of shares of a mutual fund by you may also generate taxes in a non tax-qualified account. When you redeem shares of a mutual fund, you realize a capital gain or loss if the sales price differs from your cost basis in the shares you sold. You may generate capital gains or losses on any sale of fund shares, including sales of shares in a tax-exempt fund held outside a tax-qualified account.

Exchanges between funds held in a non tax-qualified account may also generate taxes for you because an exchange from one fund into another fund is considered a sale and purchase for tax purposes. Therefore, if the sales proceeds out of the fund differ from your cost basis of the sold shares, the exchange will result in a capital gain or loss. Even if the exchange does not result in a capital gain or loss, your holding period in the new fund will begin as of the date of the exchange, not the date of purchase of the old fund.

Your capital gains and losses are categorized as short term or long term for federal income tax purposes.

  • If you held your shares of the mutual fund for 12 months or less, your capital gain or loss from fund share sales or exchanges will be categorized as a short-term capital gain or loss.
  • If your shares were held longer than 12 months, you'll realize a long-term capital gain or loss.

The amount of federal income tax you pay depends on your holding period and your particular tax bracket.


Risk Disclosures

Income may be subject to state and local taxes and (if applicable) the Alternative Minimum Tax.

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