• Basics
• Mutual Funds
• Retirement
• Stocks & Bonds

Mutual Funds:

Mutual Fund Terminology

Any distribution of money your client receives from a mutual fund is usually a capital gain distribution, an exempt interest dividend, nontaxable return of capital, or an ordinary dividend.

• An ordinary dividend is paid out to your client from its earnings and profits. It is reported as dividend income on their tax return.
• Capital gain distributions are long term net realized capital gains from the fund. The money is based on projections of how well the fund would do. Your client reports them as long term capital gain on their tax return regardless of the amount of time they have had ownership of the funds. A small part of this is undistributed capital gains. These are like a ghost income, your client never has it in their hands but they have to pay taxes on it anyway. They can claim these as a tax credit on their return because they are considered to have paid them.
• Exempt interest dividend is paid from tax-exempt interest earned by the mutual fund. Hence, your client does not have to pay taxes on this dividend, but they must report it nevertheless.
• When your client receives money out of their mutual fund that is not part of the earnings or profits but are part of their investment, it is called a nontaxable return of capital. The money is tax free because that was part of their principal in the fund. This reduces their basis in the mutual fund. Even when the basis becomes zero, your client must report it on their tax return as capital gain.