Calculating Taxes Due on Mutual Funds

Mutual funds are professionally managed pooled investments. When you buy shares of a mutual fund, you own a piece of the underlying portfolio. Mutual funds can invest in stocks, bonds, precious metals and other items. Your mutual funds send you standard Internal Revenue Service forms shortly after the end of the year that help you prepare your tax returns.

Ordinary Income

Mutual funds normally pay no taxes if they distribute almost all of their income and capital gains to shareholders. Mutual funds report distributions on Form 1099-DIV, including those that arise from interest and nonqualified dividends. These distributions are ordinary income taxed at your marginal tax rate. You report taxable ordinary distributions on Form 1040. Form 1099-DIV also reports your exempt-interest dividends, which are normally free from federal income tax. Exempt-interest dividends typically are interest payments from tax-free municipal bond funds.

Dividends

Most U.S. corporate dividends qualify for capital gains tax rates. Many foreign corporation dividends also qualify, as long as the dividend-paying stock is readily tradable in the United States. Nonqualified dividends include those issued by non-profit entities and real estate investment trusts. Form 1099-DIV reports qualified dividends, including those from mutual funds. You must hold the mutual fund for at least 61 days surrounding the ex-dividend date of otherwise qualified mutual fund dividends to take advantage of capital gains rates.

Capital Gains

Capital gains and losses arise from selling a security or other asset. Mutual funds provide two sources of mutual funds. When the mutual fund sells part of its portfolio, it records a gain or loss and reports net gains on Form 1099-DIV. The IRS instructs you to treat these gains as long-term, no matter how long you’ve held the fund. The second source of capital gains and losses stem from your sale of mutual fund shares. Mutual funds report these gains and losses on Form 1099-B. The form reports short- and long-term sales separately. Report 1099-B capital gains on IRS Form 8949 and then summarize the results on Schedule D of Form 1040.

Capital Gains Tax Rates

Short-term capital gains arise from the sale of shares you hold for a year or less. The IRS taxes these at your marginal tax rate. Long-term capital gains, as well as qualified dividends, are taxed at a lower rate. If your modified adjusted gross income, or MAGI, exceeds certain thresholds, your tax rate on long-term capital gains is 20 percent. The 2013 thresholds are $400,000 for individuals and $450,000 for married couples filing jointly. If you don’t meet these thresholds, your tax rate is 15 percent if your tax bracket is 25 percent or higher. Otherwise, the gains are tax-free. Capital losses offset capital gains and up to $3,000 of ordinary income. You can roll unused capital losses into future tax years.

Medicare Surcharge

Beginning in 2013, you must pay a 3.8 percent Medicare surcharge if you are an individual with MAGI exceeding $200,000. The threshold for married couples filing jointly is $250,000. The IRS levies the tax on the lesser of your net investment income and the amount by which your MAGI exceeds the noted thresholds.