Mutual funds offer an efficient means of combining investment diversification with professional management. Their income tax effects can be complex, however, and poorly timed purchases or sales can create unpleasant year-end surprises.

Mutual fund investors (excluding qualifying retirement plans) are taxed based on activities within each fund. If a fund investment generates taxable income or the fund sells one of its investments, the income or gain must be passed through to the shareholders. The taxable event occurs on the date the proceeds are distributed to the shareholders, who then owe tax on their individual allocations.

If you buy mutual fund shares toward the end of the year, your cost may include the value of undistributed earnings that have previously accrued within the fund. If the fund then distributes those earnings at year-end, you’ll pay tax on your share even though you paid for the built-up earnings when you bought the shares and thus realized no profit. Additionally, if the fund sold investments during the year at a profit, you’ll be taxed on your share of its year-end distribution of the gain, even if you didn’t own the fund at the time the investments were sold.

Therefore, if you’re considering buying a mutual fund late in the year, ask if it’s going to make a large year-end distribution, and if so, buy after the distribution is completed. Conversely, if you’re selling appreciated shares that you’ve held for over a year, do so before a scheduled distribution, to ensure that your entire profit will be treated as long-term capital gain.

Most mutual fund earnings are taxable (unless earned within a retirement account) even if you automatically reinvest them. Funds must report their annual distributions on Forms 1099, which also indicate the nature of the distributions (interest, capital gains, etc.) so you can determine the proper tax treatment.

Outside the funds, shareholders generate capital gains or losses whenever they sell their shares. The gains or losses are computed by subtracting selling expenses and the “basis” of the shares (generally purchase costs) from the selling price. Determining the basis requires keeping records of each purchase of fund shares, including purchases made by reinvestments of fund earnings. Although mutual funds are now required to track and report shareholders’ cost basis, that requirement only applies to funds acquired after 2011.

When mutual funds are held within IRAs, 401(k) plans, and other qualified retirement plans, their earnings are tax-deferred. However, distributions from such plans are taxed as ordinary income, regardless of how the original earnings would have been taxed if the mutual funds had been held outside the plan. (Roth IRAs are an exception to this treatment.)

If you’re considering buying or selling mutual funds and would like to learn more about them, give us a call.

*This newsletter is issued quarterly to provide you with an informative summary of current business, financial, and tax planning news and opportunities. Do not apply this general information to your specific situation without additional details and/or professional assistance.

Wedding bells bring rejoicing – and financial changes. If you’re marrying for the second time, the changes might seem overwhelming. On the surface, tax and financial planning for a second marriage is similar to that of a first marriage, but there’s more to taxes and marriage the second time around.

For example, no matter what month you hold the ceremony, the IRS will consider you married for the full year. That means employer-provided fringe benefits and taxes withheld from your paychecks could require adjustment. Depending on how much each of you earns and your past financial history, you’ll have to decide what filing status will be most beneficial, and how best to take advantage of tax breaks that may become available.

With a second marriage, you have even more decisions to make, including how you’ll merge your assets. Will you purchase a new home? If both of you already own separate homes, you may each qualify for a $250,000 federal income tax exemption on the profit from the sale, as long as you have lived in the home for at least two of the last five years. If only one of you meets the requirements for the exemption, consider selling the qualifying home and living in the other for a while.

You or your spouse might also have substantial debt or financial obligations. Discuss your financial histories, including alimony or child support still owed and past bankruptcies. Decide who will provide for the college expenses of the children in your now-combined household. Depending on your age, you may want to investigate the effect of the marriage on your social security benefits.

Consider estate issues too, such as updating retirement plans with new beneficiary designations and retitling bank and brokerage accounts. Be sure to discuss how heirs from previous marriages will be provided for, and remember to update your wills.

A second wedding is a joyful event for you, your new spouse, and your extended families. To give your marriage an added advantage, call us before you say, “I do.” We’ll offer our congratulations – followed by useful financial and tax planning advice.

Taxes and Marriage Checklist: After the Wedding

Don’t wait too long after the wedding to spend a little time on tax matters. Here’s a checklist of things to consider:

• If you’ve taken your spouse’s last name or hyphenated your last name, you need to notify the Social Security Administration. The agency will link your new name to your social security number and issue a new social security card.
• Update your will and other estate planning documents. Don’t forget to review the beneficiaries on your IRAs, 401(k) plan, and life insurance policies. You’ll want to make sure your documents are updated and taxes are minimized in the event of your disability or death.
• If you move to a new home, send a change of address to the IRS, the financial institutions where you have accounts, and current-year employers. Then your W-2s and IRS notices will find their way to you.
• Your marital status for tax filing is determined by your status on the last day of the year. Calculate the impact of the marriage penalty to see whether you need to change your income tax withholding. File a new Form W-4 with your employer’s payroll department to notify them of your name change and any withholding change.

If you have questions about taxes and marriage, please contact Cray Kaiser today.