Most people are familiar with mutual funds to a degree. Basically, a mutual fund is a portfolio of securities professionally managed by a portfolio manager or managers. Here is what most people don’t know: there is a commonly overlooked error with mutual funds that costs taxpayers millions in overpaid taxes. So make sure you are not making this same mistake. Let’s take a closer look.
Many people are aware that you can choose to reinvest the dividends paid by your mutual fund, usually quarterly or monthly. Reinvesting your dividends is not a tax deduction.
But this part is critical:
It is an important cost basis calculation for when you sell your mutual fund later. When a dividend is paid out, it gets taxed for that year. This is important in non-retirement accounts. Once a dividend is taxed and gets reinvested, you should not pay tax on that dividend again when you sell the mutual fund at a later date. Remember that each reinvested dividend raises or increases your cost basis in that fund. This reduces the taxable gain when you sell your shares at a later time. Former IRS commissioner Fred Goldberg told Kiplinger magazine (in their annual overlooked deduction article), that missing this break costs millions of taxpayers a lot in overpaid taxes. Again, this is a former IRS commissioner flat out telling you this is missed all the time!
This is why it’s important to keep good records.
Mark Luscombe, Federal Tax Analyst for Wolters Kluwer Tax & Accounting stated: “A lot of people with reinvested dividends fail to add those previously taxed dividends to their basis in determining the taxable gain on the sale of a stock.”
In 2012, regulators started requiring financial institutions to report the basis to investors and to the IRS. So that’s a start, but there is still a lot of inaccurate basis prior to 2012 that should be double-checked.
Forgetting to include reinvested dividends in your basis results in double taxation of the dividends; once in the year when they were paid and immediately reinvested and again later when you sell the mutual fund! This is more than your fair share, so don’t make this costly mistake.
If you have doubts, check with the mutual fund company for assistance, or check with an experienced advisor.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.