Understanding capital-gains and their tax implications is important to your clients. Here are some of the commonly asked questions about this topic with simple answers:

 

Q: What are capital gains?
A: A capital-gain is made when you or your fund manager garners a profit on an investment. Capital-gains are positive because everyone wants a profit from their investments.  However, investors' after-tax returns are greatly affected by capital-gains management.

 

Q: What is a capital-gain distribution?
A: A mutual fund usually sells a security, such as a stock or bond, when that security is no longer perceived as a long-term value or when a better investment opportunity presents itself.  Typically, a capital-gain or loss is realized as a result of the sale. Depending on how long the fund has held the security, the gain may be classified as short-term or long-term. Tax laws require that the fund's net gains be distributed to shareholders before the end of the calendar year if gains exceed losses.

 

Q: When do I have to pay taxes on my capital gain distribution?
A: Taxes on profits of capital gains are due at the time of sale. Managers must distribute profits to shareholders unless the gain is offset by other shares sold at a loss. Shareholders are required to claim these amounts, along with any other capital gains, on their federal and state income tax returns.

 

Q: What do I do with my capital-gain distribution?
A: You can either reinvest your capital gain distribution. or receive it in cash.  A bonus to reinvesting a capital gain. is that it purchases additional shares of the fund without sales charges.  In addition, reinvesting your capital gain. helps maintain your account value because the fund's share price is reduced by the amount of the distribution.

 

Q: Can a fund have high capital gains distributions but low or negative returns?
A: It is possible for a fund to experience high capital gains and low returns. This occurs when stocks with an increased value in a fund with decreased value are sold.

 

Q: Should an investor knowingly get out of a fund to avoid an impending capital-gain distribution?
A: An impending capital-gain. distribution is not necessarily a reason to sell. You may incur an even larger tax bill by selling fund shares in a long-term investment. than if you just received the distribution. The distribution may only represent a portion of the gain. you've enjoyed while selling shares would cause you to realize your total gain on that investment.

 

In addition, watch for the fund's record date if you are thinking about investing in a new fund or diverting dividends into a different fund. You may end up buying the dividend or distribution if you purchase a new fund right before its record date.

 

Plan Ahead Now
Although it may be difficult to focus on the future with an impending tax bill, now is the best time to plan. 

These steps may help reduce tax headaches:

Paying taxes on investments is never desirable, and this year the burden may seem heavier than usual for many mutual fund investors. With large capital-gains distributions occurring across the industry, understanding capital-gains and their implications can help investors address issues that directly affect their returns and their tax bills.