How Investing Impacts Your Taxes
Sales and Exchanges of Mutual Fund Shares
Sales and exchanges of mutual fund shares usually result in either a capital gain
or loss to the investor.
Investors are liable for tax on any of the capital gains that may arise from the
sale of fund shares, just as they would be if they sold any other security such as
a stock or bond. Capital losses from mutual fund share sales and exchanges may be
used to offset other capital gains in the current year and thereafter. Capital gains
or losses are determined by the cost basis of the shares (price for which the shares
were purchased, including reinvested dividends), and the price at which the shares
were sold.
Mutual Fund Distributions
A mutual fund generally distributes all of its earnings each year and is taxed only
on amounts it retains. Therefore, the fund's earnings typically are taxed only once
when received by the fund's shareholders. There are 2 types of taxable distributions
to shareholders that mutual funds make every year: Dividend Distributions and Capital
Gains Distributions.
- Dividend distributions come primarily from the interest and dividends earned by
the securities in a fund's portfolio, after expenses are paid by the fund. These
distributions must be reported as dividends on an investor's tax return.
- Capital gains distributions represent a fund's net gains, if any, from the sale
of securities held in its portfolio for more than one year. When gains from these
sales exceed losses, they are distributed to shareholders.
Special News-Dividend, Capital Gains Taxes Reduced
The Jobs and Growth Tax Relief Reconciliation Act of 2003, signed into law by President
Bush on May 28, 2003, included a provision that reduces tax rates on dividends and capital
gains. As a result, the highest rate investors generally will pay on long-term capital
gains is 15%, down from 20%. Dividends, which used to be treated as ordinary income and
were taxed at up to 38.6%, are now subject to a maximum tax rate of 15%. For example,
investors in the top income-tax bracket generally will now pay $15 out of every $100 they
earn from stocks (or stock mutual funds), vs. $35 for every $100 they earn from bonds. For
taxpayers in the 10% and 15% ordinary income tax rate brackets, the rate on dividends and
capital gains is reduced to 5% in 2003 through 2007, and to zero in 2008.*
Rollovers of Retirement Accounts
If you are leaving a job, distributions and early withdrawals from a tax-qualified retirement
plan like a 401(k) may result in a 20% mandatory federal tax withholding and tax penalties at the
federal, state and, possibly, local level.
You can avoid the serious impact of taxes and penalties by
rolling over your plan's assets directly into an IRA or another
employer sponsored plan.
Early Withdrawals from Retirement Accounts
Traditional IRA - The portion of each distribution that represents the return of
deductible contributions and IRA earnings is taxed as ordinary income at the time the
distribution is taken. Distributions taken before you reach age 59½ may also be subject
to a 10% penalty tax*.
