For investors with taxable mutual funds, the beginning of a new year can provide the opportunity for a fresh approach to capital gains. Many investors will soon receive tax forms from their mutual funds, which can include information about how much they might have received in capital gains, which they must pay taxes on when they file their tax returns.
Capital Gains Can Be Taxing
Often, decisions about when to realize capital gains are completely out of an investor’s control, as when fund managers’ choices about what to buy and sell during the year dictate the realization of capital gains at year’s end. The timing around distributions can make it difficult to avoid paying a related tax bill. By waiting until the end of the year to consider the impact of mutual fund distributions on their tax situation, investors may need to work with their advisor and a tax professional to react quickly by selling shares of stock or mutual funds at a loss to offset those gains.
If an investor elects to reinvest dividends, then they may not have the cash to pay the tax bill. In some cases, investors can find themselves on the end of a double whammy – paying taxes on funds that actually lost money.
Understanding Long and Short-Term Gains
Mutual funds distribute two types of gains – long-term and short-term, which can have varying impact on an investor’s tax situation. Here’s an overview:
|Short-Term Gains||Long-Term Gains|
|Holding Period||Less than 1 year||More than 1 year|
|Tax Rate||Ordinary income||15% to 20%|
|Offset||Other short-term gains, then long term gains1||Other long-term gains, then short-term gains, up to $3,000 of ordinary income|
The beginning of the year is a good time to proactively work with an advisor and a tax professional to craft a strategy for the future that could help lower their tax bill. Here are some potential tactics:
- Analyze historical patterns: While past fund distributions are not predictive of future distributions, they may be able to give you an idea of what a manager and fund’s history is in terms of distributing capital gains. Investors can analyze all of their funds to get an idea of what they’ve distributed in the past.
- Consider a tax-managed account: Working with a tax professional, investors have the option of initiating an investment in a tax-managed account that could help protect them from future capital gains bills and may increase the overall tax efficiency of their investment portfolio. Some investors may want to consider a proactive strategy of putting a small percentage of their taxable assets in a tax-managed account to avoid paying capital gains tax.
Visit our Taxes page to stay up to date on issues related to investing and tax management. Stay up to date on market trends and investor sentiment at our Latest Insights page.
1 Some funds distribute net short-term gains as income, which cannot then be offset with short-term or long-term capital losses outside the fund. In these cases, distributions are taxed at investor income rates.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Natixis Global Asset Management does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions.
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