As many readers here will likely already know, mutual funds are an excellent way for you to manage the financial resources of you and your other investors.
Whether it funds for stock, equity, bond or fixed income, or money market funds, they are great ways to invest in many different open-ended security funds.
However, just like with any other major pooling of financial resources from multiple people or groups, there also comes a heavy amount of management and regulations that come with something like mutual funds.
And the legal consequences for not following them can pretty quickly mount if you aren’t careful, so it is vital to understand how these funds can interact with the rest of your finances.
One of the bigger elements that investors, especially those just entering the financial sector, is how mutual funds can affect your taxes, as well as if you have to pay taxes on these funds themselves.
Without any clear advice, this can often be the biggest hurdle to new investors setting up mutual funds.
Well, that is what we are here to help clear and discuss! In this guide, we are going to explain whether you have to pay taxes on any mutual funds you may have, as well as how your taxes and funds can interact with each other.
We’re also going to cover whether or not there are any ways for you to qualify for or reduce the amount of tax that you need to pay on your mutual funds.
Do You Have To Pay Taxes On Your Mutual Funds?
Before we go any further in discussing how your mutual funds are managed, we should probably answer the main question of this guide first: Do you have to pay taxes on the mutual funds that you do have?
The short answer to this question is: Yes, you do have to pay some kind of tax on that mutual fund you have just opened. At least, in most cases (more on that later).
The long answer is a little more complicated. Like with many large movements of funds, when earnings and similar payouts to a company’s investors, the transaction is known as a distribution.
When a mutual fund-focused company makes its distributions towards the end of the year, those amounts of estimated and calculated by the gains made by the capital in the other earnings made from the mutual, once the expense of keeping the account up and running is taken away from that amount.
If you hold any shares in a mutual fund that is considered a taxable account, then you need to be paying taxes based on the number of distributions that the mutual fund has made over the year.
This applies whether the mutual fund distributions were paid out in cash, or were again reinvested in any type of additional or extra shares.
What’s more, the responsibility of reporting any transactions that take place with this mutual fund organization will likely fall to you.
Not only that but the correct type of tax on each type of income that is earned through the mutual fund must also be determined by you.
The Types Of Mutual Fund Income
So, if you have to establish what kind of income you made through your mutual fund for yourself, what types of income are they exactly? And how do they need to be measured by you, exactly?
The following are several different incomes that mutual funds can be used for, and how they need to be taxed.
Short-Term Capital Gains
This type of distribution is net gains that the mutual fund has made from the sale of any shares that were held by the fund over a single year or less.
These gains are usually subject to most ordinary tax rates of income, as they are often treated as ordinary dividends by the company that owns or invests in the mutual fund.
Long-Term Capital Gains
As the name implies, these distributions are share sales made with the mutual fund that is held for more than a year.
In these cases, these gains are treated at capital gain rates of tax, which are more often than not lower than the ordinary income tax rates that you may expect.
These distributions are dividends that are paid by stock from domestic corporations, as well as foreign companies that qualify for contributing to the mutual fund.
Depending on the restrictions and if there is a holding period, this type of distribution is usually taxed at the same rate as capital gains that are considered long-term.
Non-Qualified Or Ordinary Dividends
These distributions are made by interests or individuals who do not qualify for a lower rate of tax, according to the IRS.
This is often considered a term that is applied to many other taxable incomes, outside long-term gains from any capital and is usually at an ordinary income rate for the amount.
This kind of distribution is usually interest from some kind of fixed security payment that the mutual fund has received. The interest from these distributions is usually taxed at other ordinary tax income rates as other similar amounts of interest.
Similar to the taxable interest, federal interest is a distribution that comes from a federal debt instrument, especially those that have maturities older than 20 years.
As the name implies, they are taxed at the normal federal rate of income but can be exempt from most state income rates.
These are bonds from municipal or state bonds. As their name suggests, they are exempt from federal tax but check your local state for further rules.
As you can see, mutual funds can be taxed in a variety of ways, so it pays to stay updated on those means, depending on what you are using the mutual fund for.