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Investing :  Mutual Funds

You should consider the tax consequences of investing in mutual funds. When you sell or exchange shares from a fund, you may trigger a taxable event. Other taxes may be created from dividend or capital gains distributions fund companies generally issue at the end of the year. In either case, you'll be responsible for the tax liabilities.

Distributions

Distributions are paid to shareholders at the end of each year, normally around December.

They consist of the following:

• Ordinary Dividends
  Includes dividend or interest income and any short-term capital gains -- resulting from equities sold after being held less than a year. You're taxed at the same rate as your normal income taxes. State or local taxes may also apply to your investment.
  
  
• Capital Gains Distributions
  Includes long-term capital gains -- resulting from equities sold after being held longer than a year. You're taxed at rate that is determined by how long the fund held the security before selling it. State or local taxes may also apply to your investment.
  

There are a variety of ways distributions can be allocated. If you seek additional growth for your investments, you might decide to reinvest both capital gains and dividends to buy additional shares of the fund. Or you might elect to take the distributions as cash or redirect them toward the purchase of shares in another fund category.

Your selection is a personal one and should complement your overall financial plan.

Taxes

You're required to report capital gains and dividend income to the IRS when you file your federal income tax return. Your fund company should mail you a Form 1099-B or 1099-DIV outlining transactions that occurred during the year. These include fund distributions or redemptions of shares from the fund.

Even if you automatically reinvest capital gains or dividends back into your fund, you'll be liable for paying taxes. The IRS considers distributions income regardless of how they're allocated.

Reinvested distributions are taxed only once -- that means they become part of the cost basis for any shares you've purchased. When you sell shares from the fund, you should deduct this amount from the sales price -- and avoid paying taxes twice.


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