This article briefly lists the rules for reporting the most common distributions from mutual funds for federal tax purposes.
A mutual fund is required by law to pass on essentially all of its profits annually to its owners, the shareholders, in order to avoid being taxed on that income. These payments include both capital gains distributions and dividends, and are commonly made towards the end of each calendar year.
A mutual fund documents the distributions it makes on a form 1099-DIV sent to its shareholders. Each type of distribution appears in its own numbered box. The most common distributions reported on Form 1099-DIV are ordinary dividends, qualified dividends, and capital gains. Here’s how to report this information on a U.S. federal tax return as of 2006:
- Ordinary dividends from the appropriate box should be reported on Form 1040, line 9a.
- Qualified dividends should be reported on Form 1040, line 9b.
- Capital gains distributions should be reported on Schedule D, line 13. Alternately, if you have no other use for schedule D, then these should be reported on Form 1040, line 13. Note that capital gains distributions are long-term gains by definition (also see below).
Also see the related FAQ article about buying a fund that is about to make a taxable distribution.
You might have wondered about short-term versus long-term capital gains from a mutual fund. By law, short term gains earned in a mutual fund lose their capital nature, and become ordinary income that is distributed to shareholders in the form of dividends. So the mutual fund’s short-term gains must be reported on the shareholder’s tax return as ordinary dividend.
Long term capital gains of the fund, on the other hand, are reported to shareholders as capital gains distributions. They are are always long term in nature and should be reported on Schedule D, Line 13 as long term gain distributions, subject to favored tax rates and netted against any capital losses or loss carryovers.
If a fund reports short term gains, and it cannot be in a numbered box, it leads some taxpayers to try to net those gains against loss carryover. That’s a no no. I believe that short term gains earned by the fund should not even be reported, due to this confusion.
For example, if you have a capital loss of 20,000 and own a mutual fund which had 20,000 of short term gains, you cannot, repeat, cannot use more than 3,000 of those short term gains to net against the 20,000 of capital loss. All you can do is use up 3,000 of your loss this year and declare 20,000 of dividends, taxed as ordinary income.
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Contributed-By: Art Kamlet, Chris Lott