The Wall Street Journal (Saunders, 2015) recently reported that many mutual funds in 2015 will report large capital gain distributions. Investors who own funds in a taxable account, must pay tax on their distributions each year, even if they are reinvesting them in more shares. These gains, if large enough, may unexpectedly swing you from having a refund to owing taxes in April.
Is this your situation? Why does this happen? What does it mean for high-income tax payers? How do you minimize the tax hit? Read more to find out.
Is this your situation? Review your taxable accounts for investment holdings and their capital gain distributions reported in 2015. Or contact your financial adviser and ask if they can help you estimate your 2015 capital gain distributions (note that the feasibility for them to do this depends on your investments).
Why does this happen? Each year, mutual funds must pay out almost all of their realized net capital gains, meaning gains on assets they have sold minus losses on assets they have sold. Resulting in capital gain distributions.
High-income taxpayers get an extra hit. If you earn more than $200,000 for single filers or $250,000 for joint filers, then your capital gains and other investment income will be subject to the extra 3.8% tax.
How do you minimize the tax hit? First, offset capital gain distributions with capital losses under a strategy called "tax loss harvesting". Second, to reduce the impact in future tax years hold your mutual funds in retirement accounts (e.g., IRAs) instead of taxable accounts. Under the second structure, capital gains are distributed tax free while in your retirement account.
Where do I go for more help? For either plan, it may be beneficial to work with your financial adviser and Hoppe Tax to develop an investment strategy that considers your specific tax scenario.
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Saunders, Laura. 2015. “Beware of Tax Surprises Lurking in Mutual Funds.” Wall Street Journal. http://www.wsj.com/articles/beware-of-tax-surprises-lurking-in-mutual-funds-1444987800?tesla=y
CPA + Partner at Why Blu