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Mutual fund taxes

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The following information is excerpted from the U.S. IRS website.*

Individual shareholders of mutual funds must report distributions paid by a mutual fund and any expenses connected with the investment. There are five types of distributions from mutual funds you should be aware of, each of which has different tax implications.

Ordinary dividends

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.

Qualified dividends are:
  • Tax-free for those in the 10% and 15% brackets to the extent qualified dividend income remains within those brackets
  • Taxed at a 15% rate for those in the 25% up to 35% tax brackets
  • Taxed at a 20% rate for higher income taxpayers whose income surpasses the 35% tax bracket

Ordinary dividends are taxed at the same rates as ordinary income (currently a 39.6% 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 U.S. 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.

Exempt-interest dividends

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.

Non-dividend distributions

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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Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information.  Read it carefully.

Diversification/asset allocation does not ensure a profit or guarantee against loss.

Fidelity does not provide legal or tax advice and the information provided above is general in nature and should not be considered legal or tax advice. Consult with an attorney or tax professional regarding your specific legal or tax situation.

The Fund Evaluator is provided to help self-directed investors evaluate mutual funds based on their own needs and circumstances. The criteria entered is at the sole discretion of the user and any information obtained should not be considered an offer to buy or sell, a solicitation of an offer to buy, or a recommendation for any securities. You acknowledge that your requests for information are unsolicited and shall neither constitute, nor be considered as investment advice by Fidelity Brokerage Services, LLC., Fidelity Distributors Corporation, or their affiliates (collectively, "Fidelity").
*As of 10/2012
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