Mutual Funds and Taxes Question

[readytorock]

Hey guys, I have a question about investing in mutual funds.

This is a personal after-tax-dollars investment, not in a retirement account.

If I invest, I realize I have to pay taxes on the dividends the fund pays/reinvests annually. But I was reading that I also have to pay taxes at the time I sell the funds. Isn't that double taxation? If I invest after-tax dollars, and pay taxes on my dividends every year, what's left to tax when I sell?

I plan on investing in a bond fund, not stocks or money-market.

Thanks for any help understanding this.

[EEinNJ]

There's 2 different kinds of tax here. The dividend income is taxable as ordinary income, like interest. When you sell, it's a capital gain/loss. If you were buying a stock fund (and this may be true if your bond fund has turnover) there is also an end of year capital distribution which is taxable. This is because the fund may sell holdings.

[readytorock]

But if I choose to sell a portion of my mutual funds, I won't ever pay taxes on the money I put in, or the money (like dividends) that I've already paid taxes on, correct?

I guess that was my concern. The FAQs I was reading weren't very clear on that.

[EEinNJ]

Just like a stock, If the NAV (share price) is higher when you sell, you pay a capital gain.
You pay tax on dividends. If you re-invest the dividends, when you sell those shares you pay tax.

Brokerages keep track of that for you. Schwab, for example, provides you a report for tax purposes.

[creditcardfree]

But if I choose to sell a portion of my mutual funds, I won't ever pay taxes on the money I put in, or the money (like dividends) that I've already paid taxes on, correct?

I guess that was my concern. The FAQs I was reading weren't very clear on that.

Right, you are only paying taxes on the gain when you sell.

If you bought once at $10/share, and then sold five years later at $15 per share. All the shares you bought would have had a gain of $5...you pay tax only on that portion.

Any shares you buy with reinvested dividends, will be tracked with the price you bought them at. If those shares also increase in price you will pay taxes on the gain portion when you sell.

You are taxed on the dividends, just like you are taxed on your income. All the money you are using to buy shares, whether it is from your paycheck or reinvested dividends, has thus been taxed. Only the gain from your purchases is taxed when you sell.

You will also pay taxes on the funds capital gains. If the fund has to sell some of its shares of X company and does so at a gain. The gain is divided amoung all shareholders to pay a portion of taxes on. As a shareholder, you do not have any control over whether the fund will have a capital gain or not.

I hope I was clear. Ask if it was not.

[readytorock]

Thanks so much for the information. =)

[MonkeyMama]

To be more clear, stock sale price - cost basis = taxable gain.

Cost basis = price paid for stocks (mutual funds) + dividends received.

Short answer - no - you don't get double taxed on dividends.