Don't You Just Love Unexpected Tax Bills?

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Don’t you just love unexpected tax bills?




Most of the time, investors don’t mind capital gains. In fact, when markets are rocking along paying a capital gain tax is a welcomed thing, after all you made more money right?

With the S & P 500 down over 15% this year, many mutual fund investors will be hit with a capital gains tax liability even while their portfolio values are down.

Let’s look a little deeper into why this is. To understand it better you need to know a few things first.

There are two types of capital gains experienced in mutual fund investing. The first happens when you sell a share for a price higher than what you paid. The second happens when the money manager sells holding inside the fund (individual equities) for a price higher than they paid. This profit must be paid out to you, the shareholder, in the form of a capital gains distribution.

There are two types of these distributions:

👉 Long term – a position held over 12 months

👉 Short term – a position held less than 12 months

The tax liability for each is the biggest difference.

Long term gains are taxed at one of three rates: 0%, 15% or 20%, while short term capital gains are taxed as ordinary income. You can see how you would prefer a long-term gain over the short-term gain.

The hardest thing to remember in down markets is that these gains are not tied to how well the fund is doing or even the overall market. They are simply a result of decisions that were made by the fund manager.

Paying taxes should be part of any successful investment program but like always, check with your tax professional to see how capital gains can affect you.

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