Capital Gains Taxes Double the Blow for Investors
Hyman, Julie, The Washington Times (Washington, DC)
Analysts call it the "double-whammy."
First, the left jab - many investors' mutual funds performed poorly in 2000. Then, the right hook - come April 16, investors will be hit with capital gains taxes on those very same weak funds.
Many of the nearly half of all American households that own mutual funds are left staggering with large tax bills from fiscal 2000, even as they watch the markets dive further this year.
Robert Williams bought into a handful of mutual funds early last year. Even though the value of his portfolio has dropped 25 percent, he found out in November he would have to pay capital gains taxes totaling $25,000.
"You lose money like crazy, then you've got to pay taxes on capital gains that somebody else reaped the rewards of" when the market was up, says Mr. Williams, who owns Advanced Conservation Technologies Inc., a Gaithersburg water conservation business.
In 2000, of the more than 6,000 equity funds in existence, 2,841 had negative returns. Of those, 2,311 made capital gains distributions, according to Ramy Shaalan, senior fund analyst at Wiesenberger Thomson Financial, a Rockville fund research firm.
A capital gain is the difference between an asset's purchase price and selling price. Individuals realize capital gains when they sell anything from real estate to stocks.
Mutual funds present a unique situation for investors, because they give fund managers discretion to buy and sell stocks. That means that even though an investor may be inactive, holding onto a mutual fund, he or she can receive gains when the manager sells and realizes a gain.
Taxes on capital gains are usually 20 percent, depending on the tax bracket. Investors paid $39 billion in these taxes in 1998, according to the latest figures available from the Securities and Exchange Commission.
Mutual funds paid out an estimated $345 billion in capital gains in 2000, compared with $238 billion in 1999, reports the Investment Company Institute, an industry trade group. Not all of that is taxable, since about 65 percent of it goes into tax-deferred accounts.
But capital gains taxes are expected to reach an all-time high this year to match the highest gains ever on mutual funds in 2000, according to Wiesenberger.
Financial advisers say investors have a number of avenues they can take to avoid, or at least reduce, the impact of the taxes.
One solution is putting money away in long-term, tax-deferred vehicles such as individual retirement accounts and 401(k) plans. Several dozen congressmen have signed onto legislation that would increase the amount of tax-deferred dollars people can put into such accounts.
REDEMPTIONS ROLL IN
Financial planners say the double bite from the tax man and the falling market should not have come as a surprise.
After the market began its dive last March, mutual-fund holders started to sell shares. Money managers who received those redemptions were put in a tight spot, since they were low on cash - everything was tied up in the market.
So they began selling.
"As money managers try to better their positions and returns, they're generating capital gains," says Lambert Boyce, an accountant and financial planner with Clifton Gunderson in Baltimore.
The investors who held onto the funds were left with capital gains distributions, a piece of the profits made from selling stocks that are usually paid out at the end of the year. Though investors had cash in hand, many saw the value of their funds drop.
For example, Delaware Pooled Mid Cap Growth Equity lost 9.71 percent of its value last year. But the fund paid out 61.99 percent of its assets, or $6.43 per share, in distributions to its holders, an arrangement Mr. Shaalan calls "heartbreaking" in a report because investors will have to pay taxes on those gains.