How Mutual Fund Dividends Are Taxed

Taxation of Mutual Fund Dividends

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Knowing how mutual fund dividends are taxed can help investors choose the best funds to buy and this knowledge can even improve long-term returns.

If you are looking to buy mutual funds that pay dividends, it's smart to know how dividends are taxed before buying. You may even decide that dividend funds are not the best funds to buy for your investment objectives or tax situation. You definitely don't want to wonder why you got a 1099 form in January because you didn't do your homework on mutual fund taxation in advance.

So to get you prepared for the the taxation of mutual fund dividends, we'll start with the basics by answering a few simple questions:

What Are Dividends?

Dividends are payments to shareholders (investors) of stocks, bonds, or mutual funds. These payments represent a company's profit that is divided among the shareholders. Mutual fund investors will choose if they want dividends to be reinvested (to buy more shares of the fund) or to be received as cash payment or deposited into another account.

When Are Mutual Fund Dividends Taxed?

It is important to note first that mutual fund shareholders can be taxed on a fund’s dividends, even if these distributions are received in cash or reinvested in additional shares of the fund. Also, for certain tax-deferred and tax-advantaged accounts, such as an IRA, 401(k) or annuity, dividends are not taxable to the investor while held in the account. Instead, the investor will pay income taxes on withdrawals during the taxable year the distribution (withdrawal) is made. Some mutual funds, such as Municipal Bond Funds may pay income to shareholders that is exempt from federal taxation.

For taxable accounts, such as individual and joint brokerage accounts, mutual fund dividends are generally taxed either as ordinary income (taxed at the individuals income tax rate) or as qualified dividends (taxable up to a 15% maximum rate). Ordinary and qualified dividends are reported to mutual fund investors on the tax Form 1099-DIV. For tax filing purposes, the mutual investor (taxpayer) will report dividends on Form 1040, Schedule B, and Form 1040, lines 9a and 9b.

For tax year 2016, which taxpayers need to know for their tax filing due in April of 2017, here are the tax rates for dividends:

  • Income Thresholds:  individuals and married taxpayers in the 10% and 15% tax brackets will pay 0% on eligible dividends and most capital gains.
  • Qualified Dividends:  income received will be taxed at the same rate as long-term capital gains.
  • Tax Rate:  individuals in the 25%, 28%, 33%, and 35% federal income tax brackets will pay 15% on capital gains, while taxpayers in the 39.6% bracket will pay 20%.

Where Can I Find More Information on Mutual Fund Taxation?

For more information mutual funds that pay dividends, you can refer to this article on dividend mutual funds.

If you want to keep taxes to a minimum, read this article on how to reduce taxes on mutual funds.

For more information on mutual fund taxation, you may want to contact your tax adviser or refer to IRS Publication 550.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as tax advice or investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.