Stealth Capital Gains
Many elderly (as well as non-elderly) clients have brokerage accounts which include mutual funds. Many of my clients who have these funds (like perhaps the most of the rest of us) may do nothing more than open the monthly statement from the brokerage firm and glance at the results. Though there are exceptions, most clients whom I have encountered are not active traders of these mutual funds.
Nevertheless, as Jason Zweig points out in a recent Wall Street Journal article, some of those people will be receiving IRS Form 1099s later this month showing capital gains distributions from the mutual fund which they held. How can this be when the investor did not sell any portion of the fund during the year?
The answer is that is while the account holder himself may not have sold any portion of his fund, the manager of the mutual fund did. For example, managers of mutual funds who invest in stocks may have concluded that, as a result of the gains in the stock market in 2014, it was a good time to sell certain individual stocks within the mutual fund. Because the stock was purchased by the manager at a lower price than at which it was sold–generally a good thing–this will result in capital gains to the fund. And as Jason Zweig points out:
“Mutual funds are generally required by tax law to pay out all profits they realize on the sale of their holdings. An investor outside a retirement account is typically liable for taxes on any gains the fund distributed during the tax year – even if he or she never sold a share of the fund.”
The last part – outside of a retirement fund – means outside of a so-called qualified retirement account such as an IRA, 401k or other tax-deferred account. Investors in these types of accounts will generally not be liable for the capital gains of the fund in the year in which they were incurred.
For those holding mutual funds outside of these tax-deferred accounts, however, the end of January may contain in the mail a notice that such gains were incurred and need to be accounted for in determining potential 2014 income tax liability.
This post first appeared on the Long Term Care Planning Blog on January 5, 2015.
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