Understanding mutual fund taxes
Mutual funds have several types of distributions—each with different tax implications.
Individual shareholders of mutual funds must report distributions paid by a mutual fund and any expenses connected with the investment. There are 5 types of distributions from mutual funds you should be aware of, each of which has different tax implications.
The most common type of dividends, ordinary dividends are distributions by a mutual fund out of its earnings and profits. You should include ordinary dividends as dividend income on your individual income tax return.
Many ordinary dividends you receive are also classified as qualified dividends, which are taxed at the same lower rates that apply to long-term capital gains.
Under the Tax Cuts and Jobs Act, the income ranges for the 3 rates applicable to qualified dividend income don't match up perfectly with the federal marginal income tax brackets. Instead they are applied to maximum taxable income levels for 2023 as follows:
|Long-term capital gains rate||Single taxpayers||Married filing jointly||Head of household||Married filing separately|
|0%||Up to $44,625||Up to $89,250||Up to $59,750||Up to $44,625|
|15%||$44,625 – $492,300||$89,250– $553,850||$59,750 – $523,050||$44,625 – $276,900|
|20%||More than $492,300||More than $553,850||More than $523,050||More than $276,900|
Ordinary dividends are taxed at the same rates as ordinary income (currently a 37% maximum).
In order to qualify for the 0% or 15% rate, a dividend must meet all of the following requirements:
- The dividend must have been paid by a US corporation or a qualified foreign corporation.
- The dividend must not be of a type excluded by law from the definition of a qualified dividend.
- You must have held the shares for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.
Capital gains distributions
Capital gains distributions are paid by mutual funds from their net realized long-term capital gains and are taxed as long-term capital gains regardless of how long you have owned the shares in the mutual fund.
Mutual funds may keep some of their long-term capital gains and pay taxes on those undistributed amounts. You must report your share of these unpaid distributions as long-term capital gains, even though you did not actually receive a distribution. You can claim a credit for your share of any tax paid because you are considered to have paid it.
A mutual fund may pay exempt-interest dividends to its shareholders if it meets certain requirements. These dividends are paid from tax-exempt interest earned by the fund. Since the exempt-interest dividends keep their tax-exempt character, you do not need to include them as income on your tax return.
Although exempt-interest dividends are not taxable, you must report them on your tax return if you are required to file. This is an information-reporting requirement and does not convert tax-exempt interest to taxable interest. Also, this income is generally a "tax preference item" and may be subject to the alternative minimum tax.
A non-dividend distribution is a distribution that is not out of earnings and profits and is a return of your investment, or capital, in the mutual fund. This distribution reduces the cost basis of your shares. Your basis cannot be reduced below zero. If your basis is zero, you must report the non-dividend distribution on your tax return as a capital gain.
Reinvestment of distributions
Most mutual funds permit shareholders to automatically reinvest distributions in more shares in the fund, instead of receiving cash. You must report the reinvested amounts the same way you would report them if you received them in cash. This means that reinvested ordinary dividends and capital gain distributions generally must be reported as income. Reinvested exempt-interest dividends generally are not reported as income.
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