Newspaper article St Louis Post-Dispatch (MO)

Buyer Beware: Some Funds May Come with a Tax Bill

Newspaper article St Louis Post-Dispatch (MO)

Buyer Beware: Some Funds May Come with a Tax Bill

Article excerpt

This has been a great year for mutual fund shareholders. The average domestic growth fund has climbed nearly 29 percent since the end of 1994, and even the average U.S. government bond fund is up more than 14 percent.

Naturally, investors who shared in those gains must eventually pay taxes on them. That's fair enough.

But this isn't fair at all: If you invest in some of these funds now, you also might have to pay those taxes - even though you didn't get a piece of the fund's profits!

To put it another way, many investors will pay big capital gains and income taxes for gains posted by funds in 1995 even though the investors didn't actually participate in those gains.

Fortunately, you can avoid that fate if you understand how funds distribute their gains to shareholders, and are willing to make a few phone calls to your fund sponsors.

First, the facts. In late December, many equity and income funds will make year-end distributions of the capital gains that they earned during the past 12 months. At the same time, some funds will make year-end income distributions (although many funds make these payments on a monthly or quarterly basis). This year, those distributions are likely to be big.

Here's an example of how those distributions could leave you paying taxes on profits you didn't receive.

Let's say you invest in a fund trading at $11 a share just before it makes its annual capital gains distribution to shareholders. Assume that the distribution equals $1. When the distribution is made, the share price will decline from $11 to $10, and you will receive a $1 payment for each share you own, as will the other shareholders. Your total holdings - the fund shares ($10) and the distribution cash ($1) - still amount to $11.

That seems right. But here's the problem: You'll owe tax on the $1 distribution - even though it represents part of your original $11 investment, not a profit. …

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