How Are Mutual Funds Taxed

When it comes to how mutual funds are taxed, they are treated basically the same as other investments in the eyes of the IRS. If you make profit from your mutual fund, you are required to report it as income and taxes on said income must be paid. The world of finance refers to income earned from investments as capital gains. The tax laws regarding mutual funds are quite similar to other investments such as stocks, but the funds themselves are quite different. Mutual funds aren’t taxed exactly like stock market profits are for various reasons.

Owning stock means you own a part of a company. Being part of a mutual fund means you own units of that fund. Therefore, the taxation process is a bit different. When figuring out the taxes on a mutual fund, you need to know both the original and current price of your investment. Cost basis is the term used to describe the cost of the investment, which refers to the average price of the mutual fund following adjustments due to distributions or stock splits.

Let’s take a look at a theoretical example. You own 50 units of a mutual fund that you purchased for $5 per stock, making the total investment cost $250. If you earn a capital gain of, say, $20, it is reinvested into your mutual fund. This is then calculated to see how many units can be bought with this gain. You divide the cost of the units by the number of units owned. This helps you figure out the cost basis for one mutual fund unit. The Internal Revenue Service requires taxes to be paid on earnings above the cost basis per unit.

If this sounds confusing, don’t worry. There are plenty of financial professionals and tax professionals out there who can help you make sense of it all. If like many people, you have your taxes prepared by a professional, you will not even need to worry with calculations, as your tax preparer will do all the work and give you all the information you need.

Taxes on mutual funds are not substantial enough to steer any investor away from this type of investment. Mutual funds make a good addition to any portfolio and many employees invest in them as part of their employer provided 401K plan. There are mutual funds that are low risk, medium risk and high risk. You might want to stick with low risk funds, or diversify your money among the different risk levels. This is something else that an investment professional can help you decide upon if you are unsure.

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