Tax Tips
Tax Tip No. 3: Avoid Mutual Fund Dividends
Time your year-end mutual fund purchases to avoid excess taxes through dividend distributions.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
December 5, 2007
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If you're thinking of buying mutual funds between now and the end of the year, think twice -- you might be buying an unnecessary tax bill.
Sometime in December, many funds pay out dividends and capital gains that have built up during the year, and the payout goes to investors who own shares on what's known as the ex-dividend date.
Now, it might sound like a savvy move to buy just before that day, so you get a whole year's worth of income. But it doesn't work that way. Yes, you'd get the payout, but at the time of the payout, the share price falls by exactly the same amount. If you get $2 a share in dividends, the share price drops by two bucks. In effect, the fund is simply refunding part of your purchase price.
But that's not the way the IRS sees it. You have to report those payouts as income on your 2007 return -- and pay taxes on them -- even if the money is automatically reinvested in extra shares so you never really see it.
This year, mutual funds are expected to make distributions to shareholders that will top the record-setting $418 billion that they paid out last year, according to Tom Roseen, a senior research analyst for Lipper, a firm that specializes in mutual fund information. There’s a variety of reasons for the record distributions including recent market volatility that has prompted investors to move in and out of shares, forcing managers to sell stocks.
So, before you buy shares in December, call the fund or check its Web site to find out exactly when the dividend will be paid. Buy after that date and you'll not only get a lower price, but also you'll avoid a tax bill.
Reader Comments (1)
Posted by: Brian at 12/07/2007 10:43:29 AM
But provided you believe a mutal fund will continue increasing in price in 2008 (I am looking at a variety of energy funds), if you are reinvesting the distribution into new shares, wouldn't the advantage of having those additional shares be an advantage? After all, if they distribute, say, $1,000, and that's reinvested in fund shares, that's a true gain of $1,000 you didn't have if you invested after the distribution. Will it cost some in taxes? Well sure - if it's long term it'll be around $150. But isn't it worth paying $150 *in the long run* to go ahead and have that $1,000 in fund shares working for you? After all - those additional shares are purchased at the distribution adjusted price, so that $1,000 is put into the fund at the sahre value after the dsitribution. I'm not sure I understand how paying $150 in taxes does not make receiving X number of additional fund shares worth it. Maybe I'm not getting it. As long as you can swing paying the taxes, in the long run this seems like a sound strategy.