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 and which accounts are best to hold these funds. You may even decide that dividend funds are not the best funds for your investment objectives or tax situation. You 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.

Key Takeaways

  • As with stocks, dividends paid by mutual funds are taxed at your federal income tax bracket unless certain holding periods are met, in which case the "qualified dividends" may be taxed at a lower rate.
  • To minimize or avoid taxation, consider holding funds that pay dividends in a tax-advantaged account, such as an IRA or 401(k).
  • Investors should also be aware of the taxation on mutual fund capital gains distributions.

What Are Dividends?

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

Mutual Fund Dividend Taxation

Mutual fund shareholders can be taxed on a fund’s dividends, even if these distributions are received in cash or reinvested in additional shares. 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 pays income taxes on withdrawals during the taxable year the distribution is made.

Some mutual funds, such as municipal bond funds, may pay income to shareholders that is exempt from federal taxation, even if held in a taxable brokerage account. For taxable accounts, such as individual and joint brokerage accounts, mutual fund dividends are generally taxed either as ordinary income, taxed at the individual income tax rate or as qualified dividends, taxable up to a 20% 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 reports dividends on Form 1040, Schedule B, and Form 1040, lines 9a and 9b.

For the tax year 2021, the tax rates for dividends are:

  • Income thresholds: Individuals and married taxpayers in the 10% and 12% federal income tax brackets pay 0% on eligible dividends and most capital gains. Those in the 22%, 24%, 32%, and 35% pay 15% in taxes, and those in the 37% bracket pay 20%.
  • Qualified dividends: Income received is taxed at the same rate as long-term capital gains.

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.

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