You can wind up paying taxes on gains earned by the fund before you were even a shareholder
In last week’s Tax Guy column, I pointed out that one big negative about equity mutual funds is that you don’t have much control over taxes. The fund decides which investments to sell and when. If the fund sells investments that have gone up in value since they were acquired, the resulting gains will be passed out to you in the form of dividend distributions.
The proposed Biden tax plan would also increase the maximum federal rate on net long-term capital gains, including those from mutual fund distributions, to 39.6% for gains recognized after April of this year, though the exact timing is still unclear. After tacking on the 3.8% NIIT, the maximum effective rate would be 43.4% compared to the current maximum effective rate of “only” 23.8% .
The ex-dividend factor Equity mutual funds generally distribute all of their annual capital gains to avoid having to pay the corporate income tax on those gains. This can result in large fourth quarter taxable dividend distributions. Based on this year’s stock market results so far, some of this year’s distributions could be unusually large. And they could be paid out as early as sometime in November, which will be here before you know it.
Example: The ZOOM Fund declares a $5 per share fourth-quarter dividend to owners of record as of 11/29/21. So, the dividend date of record is 11/29. The ex-dividend date is 11/30. The dividend will be paid on 12/3.
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