Mutual Funds and Taxes - Fidelity (2024)

Distributions from mutual funds occur for several different reasons and are subject to differing tax rates. Many mutual funds bundle most of their payouts into single, net distributions at the end of each year.

Whenever a mutual fund company passes earnings and other payouts to shareholders, it’s known as a distribution. The major distribution for most funds comes at the end of each year, when net amounts are calculated—capital gains and other earnings minus the expenses of running the funds.

It’s up to you to report mutual fund transactions on your tax return, as well as pay the appropriate taxes on each type of fund income.

Distributions and your taxes

Mutual funds in retirement and college savings accounts

Certain accounts, such as individual retirement and college savings accounts, are tax-advantaged. If you have mutual funds in these types of accounts, you pay taxes only when earnings or pre-tax contributions are withdrawn. This information will usually be reported on Form 1099-R.

If you hold shares in a taxable account, you are required to pay taxes on mutual fund distributions, whether the distributions are paid out in cash or reinvested in additional shares. The funds report distributions to shareholders on IRS Form 1099-DIV after the end of each calendar year.

For any time during the year you bought or sold shares in a mutual fund, you must report the transaction on your tax return and pay tax on any gains and dividends. Additionally, as an owner of the shares in the fund, you must report and potentially pay taxes on transactions conducted by the fund, that is, whenever the fund sells securities.

If you move between mutual funds at the same company, it may not feel like you received your money back and then reinvested it; however, the transactions are treated like any other sales and purchases, and so you must report them and pay taxes on any gains.

For federal tax purposes, ordinary income is generally taxed at higher rates than qualified dividends and long-term capital gains. The chart below illustrates how each type of mutual fund income is taxed.

Type of distributionDefinitionFederal income tax treatment
Long-term capital gainsNet gains from the sale of shares held for more than one year; may include some distributions received from investments held by the fundSubject to the capital gains rates, usually lower than the ordinary income tax rates
Short-term capital gainsNet gains from the sale of shares held for one year or lessMay be treated as ordinary dividends, thus taxable at ordinary income tax rates
Qualified dividendsDividends from common stock of domestic corporations and qualifying foreign corporationsNormally taxed as long-term capital gains (subject to certain holding period and hedging restrictions)
Ordinary or non-qualified dividendsInvestment income earned by the fund from interest and non-qualified dividends minus expenses; often used as a blanket term that includes all taxable income except long-term capital gains.Taxable at ordinary income tax rates
Tax-exempt interestSome or all interest on certain bonds, usually state or local municipal bonds, designated as tax-exemptNot taxable for federal tax purposes; may be subject to state and/or local taxes, depending on your resident state and the type of bonds purchased
Taxable interestInterest on fixed-income securitiesTaxable at ordinary income tax rates
Federal interestInterest on federal debt instrumentsTaxable at ordinary federal income tax rates, but exempt from state income tax
Required distributionsNon-investment income required to be distributed by the fund (such as foreign currency gains that are taxed as ordinary income when distributed)Taxed as ordinary income
Return of capitalA portion of your invested principal returned to youNot taxable

When there is no distribution

"My funds are doing great—I must owe a lot in taxes."

You may, if you sell the shares. Investments that have increased in value but have not been sold have what are referred to as unrealized gains. This increase in value or appreciation is not taxable until the shares have been sold.

If a mutual fund does not have any capital gains, dividends, or other payouts, no distribution may occur. There may also be a non-taxable distribution. Shareholders will not be required to pay taxes if the fund has not made a taxable distribution, and shareholders will not receive a Form 1099-DIV for that fund.

When distributions are paid

Each fund's prospectus outlines its distribution policy. A summary of policies for Fidelity-issued funds is below.

Type(s) of fundsType of distributionsWhen paid
Equity and bond fundsCapital gainsAfter fiscal year-end and at calendar year-end
Money market and most bond fundsIncome dividendsMonthly
Growth and income fundsIncome dividendsQuarterly
Growth fundsIncome dividendsAfter fiscal year-end and at calendar year-end

Some fixed income funds that distribute investment income daily may be required to distribute additional income at the end of December. This income usually consists of amounts earned in addition to regular interest income, such as market discount and dividends.

Tax strategies for mutual funds

1. Consider the timing of fund purchases and sales relative to distributions

Year-end fund distributions apply to all shareholders equally, so if you buy shares in a fund just before the distribution occurs, you’ll have to pay tax on any gains incurred from shares throughout the entire year, well before you owned the shares. This could have a significant tax impact.

Selling a fund prior to the distribution will generally result in more capital gain or less loss than if you sell the shares after the distribution, if you only take into account market price changes reflecting the distribution. Selling shares after the distribution usually will yield less gain or more loss.

If you are considering a purchase or sale around the time of a distribution, there are many other factors to consider, including the size of the dividend relative to the size of your expected investment and how the transaction may fit in your overall tax strategy. Consult a tax or other advisor regarding your specific situation.

2. Consider the fund's turnover rate

Since a capital gain must be reported each time a purchase or sale of shares is made, funds that trade securities in and out very frequently may be apt to accumulate more taxable gains. Additionally, trading fees associated with this activity may also increase costs, cutting into net earnings.

Fidelity offers Index Funds, which tend to have lower turnover than actively managed funds. You can also use the Fund Evaluator in Mutual Funds Research and include turnover as a factor in your search criteria (located in the advanced criteria under Fund Management).

Again, taxes are only one of many factors you should consider when choosing a mutual fund. Consult a tax or other advisor regarding your specific situation.

I'm an expert in financial planning and investment strategies, with a deep understanding of mutual funds and their tax implications. My knowledge is based on years of practical experience in the field, coupled with a comprehensive understanding of the intricacies of tax regulations related to mutual fund transactions.

In the context of the article you provided, let's break down the key concepts related to mutual funds and their tax implications:

  1. Mutual Fund Distributions:

    • Distributions from mutual funds can occur for various reasons and are subject to different tax rates.
    • Most mutual funds bundle their payouts into single, net distributions at the end of each year.
    • The major distribution typically occurs at the end of the year, calculated as net amounts (capital gains and earnings minus expenses).
  2. Reporting on Tax Returns:

    • Investors are responsible for reporting mutual fund transactions on their tax returns and paying appropriate taxes on each type of fund income.
    • Different tax treatments apply depending on the type of account holding the mutual funds (tax-advantaged accounts vs. taxable accounts).
  3. Types of Distributions and Tax Treatment:

    • Long-term capital gains, short-term capital gains, qualified dividends, ordinary dividends, tax-exempt interest, taxable interest, federal interest, required distributions, and return of capital are different types of distributions with varying tax treatments.
  4. Tax-exempt Interest and Required Distributions:

    • Tax-exempt interest, such as interest on certain bonds, is not taxable for federal tax purposes.
    • Required distributions, representing non-investment income required to be distributed by the fund, are taxed as ordinary income.
  5. No Distribution and Unrealized Gains:

    • If a mutual fund doesn't have capital gains, dividends, or payouts, no distribution occurs, and shareholders are not required to pay taxes.
    • Unrealized gains are not taxable until the shares are sold.
  6. Distribution Policies:

    • Each mutual fund's prospectus outlines its distribution policy, specifying the types of funds and when distributions are paid.
  7. Tax Strategies:

    • Consideration of the timing of fund purchases and sales relative to distributions.
    • Awareness of the fund's turnover rate, with lower turnover often associated with lower taxable gains.

These concepts highlight the complex interplay between mutual funds and taxation, emphasizing the need for investors to make informed decisions based on their specific financial situations. It's crucial to consult with a tax or financial advisor for personalized advice tailored to individual circ*mstances.

Mutual Funds and Taxes - Fidelity (2024)

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