How to Pay Taxes on Mutual Funds
Understand qualified dividends., Examine Your IRS Form 1099-DIV., Determine your income tax bracket., Establish your qualified dividend tax rate., Report your distributions., Estimate your tax liability., Define nonqualified dividends., Analyze your...
Step-by-Step Guide
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Step 1: Understand qualified dividends.
Qualified dividends are ordinary dividends that are subject to reduced tax rates.
To qualify for this special tax treatment: the dividend must have been paid by a U.S. corporation or a qualified foreign corporation, the dividend must not be "nonqualified"
and the dividend must meet the applicable holding period.
Most mutual fund investments will be with U.S. corporations.
If not, check with the Internal Revenue Service (IRS) to determine if a foreign corporation is a qualified one.Most common and some preferred stocks paid by U.S. corporations are going to be qualified stocks.
If you are unsure, check to see if your stock is nonqualified.The holding period is the time you must have owned the stock before selling it.
For common stock, the holding period is 61 days.
For preferred stock, the holding period is 91 days. -
Step 2: Examine Your IRS Form 1099-DIV.
When you have investments in a mutual fund, the financial institution responsible for managing the mutual fund will report dividends and other distributions to you using IRS Form 1099-DIV.
You should receive one annually.
Qualified dividends will be reported in box 1b of that form.If you are looking at your 1099-DIV, box 1a includes all of your ordinary dividends, which is the sum of your qualified and nonqualified dividends.
Therefore, the total in box 1b is the portion of dividends from box 1a that qualifies for the reduced tax rate., Every year the IRS adjusts their income tax brackets to account for inflation.
For the tax year 2016 (i.e., you will not use these to file your 2015 taxes), the tax bracket breakdown for a single filer is as follows:
Your rate is 10% if your taxable income is $0 to $9,274.
Your rate is 15% if your taxable income is $9,275 to $37,649.
Your rate is 25% if your taxable income is $37,650 to $91,149.
Your rate is 28% if your taxable income is $91,150 to $190,149.
Your rate is 33% if your taxable income is $190,150 to $413,349.
Your rate is 35% if your taxable income is $413,350 to $466,949.
Your rate is
39.6% if your taxable income is $466,950 and above., Based on your income tax bracket, you can determine what your reduced tax rate is for qualified dividends.
Your maximum tax rate on qualified dividends will be: 0% on any amount that would otherwise be taxed at a 10% or 15% rate. 15% on any amount that would otherwise be taxed at rates greater than 15% but less than
39.6%. 20% on any amount that would otherwise be taxed at the
39.6% rate., When it is time to do your taxes, you will report your qualified dividends on line 9b of IRS Form 1040 or Form 1040A.
Form 1040 is your standard Individual Income Tax Return.You can do so by simply copying the number found on Form 1099-DIV, box 1b to Form 1040, box 9b. , When you submit Form 1040 to the IRS, they will determine the taxes you owe or the refund you will receive.
However, if you want to double check their work, you can calculate an estimate of what you might owe on your qualified dividends.
To do so, you will first need to find your total qualified dividend amount.
Next, you will need to determine what your taxable income is.
After that you can figure out your tax rate and qualified dividend tax rate.
You will then multiply your qualified divided tax rate by your total qualified dividend amount.
This will be your estimated tax liability.
For example, assume you have $25,000 in qualified dividends for the tax year
2016.
Assume you make $300,000 in taxable income.
This means your income tax rate would be 33%.
Next you would calculate that because your income tax rate is 33%, your qualified dividend tax rate is 15%.
Therefore, if you multiply $25,000 by .15, you would get $3,750.
This would be your estimated tax liability. , Nonqualified dividends are explicitly defined by the IRS.
They include:
Capital gains distributions; Dividends paid on deposits with most financial institutions; Dividends paid from a tax-exempt corporation; Dividends paid by a corporation on employer securities held by an employee stock ownership plan; and Payments in lieu of dividends., Your ordinary dividends are in box 1a of IRS Form 1099-DIV.Your ordinary dividends include the sum of qualified and nonqualified dividends. , Unlike qualified dividends, nonqualified dividends are taxed at the normal income tax rate.
You will not receive favorable tax treatment for these types of dividends.
Therefore, you can understand your tax liability by simply finding out what tax bracket you are in.
Your income tax bracket can be determined the same way as if you were calculating qualified dividends.
You can do so by calculating your taxable income and matching it up with the applicable tax rate., Nonqualified dividends are reported on line 9a of Form
1040.You can simply copy the number from Form 1099-DIV, box 1a to Form 1040, line 9a. , The IRS will calculate your tax liability based on the information you provide on your Form
1040.
However, if you want to double check, you can look at your 1099-DIV, your tax bracket, and do some simple calculations.
First, subtract the total reported in box 1b of your 1099-DIV from the total reported in box 1a of your 1099-DIV.
This equals the amount of nonqualified dividends you received.
Next, multiply that number by your tax rate.
For example, assume you have ordinary dividends that equal $10,000 (box 1a of your 1099-DIV) and qualified dividends that equal $7,000 (box 1b of your 1099-DIV).
Next, assume you make $50,000 annually in taxable income.
That would put you in the 25% tax bracket (for 2016).
First, subtract $7,000 from $10,000 to get your total nonqualified dividend amount.
This amount would be $3,000.
Next multiply $3,000 by .25, which is your tax rate based on your taxable income.
This would give you $750.
This means you would be taxed $750 on your nonqualified dividends. , When your mutual fund sells a capital asset, in this case stocks or bonds, the difference between the price you paid for the asset and the amount you received after the sale is considered a capital gain or capital loss.For example, assume your mutual fund bought 500 shares of XYZ Corp. for $10,000.
Assume that five years later your mutual fund sold those shares for $17,000.
In this instance, you would have $7,000 in capital gain. , When your mutual fund sends you your 1099-DIV, capital gains are shown in box 2a.The amount shown will be your total capital gains for the year from that mutual fund. , Your capital gains rate will be the same as your qualified dividend rate.
Therefore, you can calculate it the same way.
Determine your normal income tax rate and then look to the IRS to determine the capital gains rate. , When the time comes to report your capital gains to the IRS for tax purposes, you will do so by writing the amount of capital gains in line 13 of Form
1040.
You can get this number by simply looking at box 2a of Form 1099-DIV.
In most cases, you will not be required to do anything else.
However, in some circumstances, you may be required to fill out Form 8949 and/or a Schedule D., While the IRS will calculate your tax liability for you based on what you report on your Form 1040, you can always estimate what your liability will be.
To do so, take the amount in box 2a of your Form 1099-DIV and multiply it by your applicable capital gains rate.
For example, assume you had $20,000 in capital gains in
2016.
This amount was reported in box 2a of your Form 1099-DIV.
You should also assume you make $500,000 in taxable income every year.
This means your income tax rate would be
39.6%.
If your income tax rate is
39.6%, it means your capital gains tax rate would be 20%.
You would then multiply $20,000 by .20 to get your estimated tax liability.
In this scenario, your estimated tax liability would be $4,000. , A prospectus is a document that will provide you with information on the taxation method for that particular mutual fund.
A prospectus will also include information on the terms, conditions, risks, and interest rates for a particular mutual fund.
Contact your financial adviser or investment company to obtain a copy of the prospectus for your mutual fund if needed. , Some mutual funds, such as municipal bonds, are exempt from federal taxes and will not require you to file a 1099-DIV form with the IRS. , These types of mutual funds are managed in a manner that allow the profits and earnings from certain shares offset financial losses you may have experienced in other shares, resulting in overall lower tax liability at the end of the year. , The portfolio of an index fund matches the components of a major stock market index, which generally has a low turnover rate in terms of capital gains.
Low capital gains will often result in much lower distributions and taxation amounts, if at all.
Examples of major stock market indexes are the Standard and Poor's 500, and the Russell
2000. , Most mutual fund distributions are issued in November or December of every year, so if you wait until after the distribution date to buy your shares, you can prevent yourself from having to pay the taxes on those shares immediately.
Check the distribution date of your mutual funds by reviewing the prospectus, or by consulting with your financial adviser or investment company prior to investing. -
Step 3: Determine your income tax bracket.
-
Step 4: Establish your qualified dividend tax rate.
-
Step 5: Report your distributions.
-
Step 6: Estimate your tax liability.
-
Step 7: Define nonqualified dividends.
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Step 8: Analyze your IRS Form 1099-DIV.
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Step 9: Determine your income tax bracket.
-
Step 10: Report your distributions.
-
Step 11: Calculate your estimated tax liability.
-
Step 12: Decide whether you have any capital gains.
-
Step 13: Look for these distributions on your IRS Form 1099-DIV.
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Step 14: Determine your capital gains tax rate.
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Step 15: Report your capital gains distributions.
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Step 16: Estimate your tax liability.
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Step 17: Read the prospectuses for mutual funds before investing.
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Step 18: Invest in tax-exempt mutual funds to avoid paying any taxes on mutual funds.
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Step 19: Invest in tax-managed
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Step 20: or tax-efficient mutual funds to minimize your taxation amount.
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Step 21: Place your money into index funds with low capital gains.
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Step 22: Buy mutual fund shares right after their yearly distribution date has passed.
Detailed Guide
Qualified dividends are ordinary dividends that are subject to reduced tax rates.
To qualify for this special tax treatment: the dividend must have been paid by a U.S. corporation or a qualified foreign corporation, the dividend must not be "nonqualified"
and the dividend must meet the applicable holding period.
Most mutual fund investments will be with U.S. corporations.
If not, check with the Internal Revenue Service (IRS) to determine if a foreign corporation is a qualified one.Most common and some preferred stocks paid by U.S. corporations are going to be qualified stocks.
If you are unsure, check to see if your stock is nonqualified.The holding period is the time you must have owned the stock before selling it.
For common stock, the holding period is 61 days.
For preferred stock, the holding period is 91 days.
When you have investments in a mutual fund, the financial institution responsible for managing the mutual fund will report dividends and other distributions to you using IRS Form 1099-DIV.
You should receive one annually.
Qualified dividends will be reported in box 1b of that form.If you are looking at your 1099-DIV, box 1a includes all of your ordinary dividends, which is the sum of your qualified and nonqualified dividends.
Therefore, the total in box 1b is the portion of dividends from box 1a that qualifies for the reduced tax rate., Every year the IRS adjusts their income tax brackets to account for inflation.
For the tax year 2016 (i.e., you will not use these to file your 2015 taxes), the tax bracket breakdown for a single filer is as follows:
Your rate is 10% if your taxable income is $0 to $9,274.
Your rate is 15% if your taxable income is $9,275 to $37,649.
Your rate is 25% if your taxable income is $37,650 to $91,149.
Your rate is 28% if your taxable income is $91,150 to $190,149.
Your rate is 33% if your taxable income is $190,150 to $413,349.
Your rate is 35% if your taxable income is $413,350 to $466,949.
Your rate is
39.6% if your taxable income is $466,950 and above., Based on your income tax bracket, you can determine what your reduced tax rate is for qualified dividends.
Your maximum tax rate on qualified dividends will be: 0% on any amount that would otherwise be taxed at a 10% or 15% rate. 15% on any amount that would otherwise be taxed at rates greater than 15% but less than
39.6%. 20% on any amount that would otherwise be taxed at the
39.6% rate., When it is time to do your taxes, you will report your qualified dividends on line 9b of IRS Form 1040 or Form 1040A.
Form 1040 is your standard Individual Income Tax Return.You can do so by simply copying the number found on Form 1099-DIV, box 1b to Form 1040, box 9b. , When you submit Form 1040 to the IRS, they will determine the taxes you owe or the refund you will receive.
However, if you want to double check their work, you can calculate an estimate of what you might owe on your qualified dividends.
To do so, you will first need to find your total qualified dividend amount.
Next, you will need to determine what your taxable income is.
After that you can figure out your tax rate and qualified dividend tax rate.
You will then multiply your qualified divided tax rate by your total qualified dividend amount.
This will be your estimated tax liability.
For example, assume you have $25,000 in qualified dividends for the tax year
2016.
Assume you make $300,000 in taxable income.
This means your income tax rate would be 33%.
Next you would calculate that because your income tax rate is 33%, your qualified dividend tax rate is 15%.
Therefore, if you multiply $25,000 by .15, you would get $3,750.
This would be your estimated tax liability. , Nonqualified dividends are explicitly defined by the IRS.
They include:
Capital gains distributions; Dividends paid on deposits with most financial institutions; Dividends paid from a tax-exempt corporation; Dividends paid by a corporation on employer securities held by an employee stock ownership plan; and Payments in lieu of dividends., Your ordinary dividends are in box 1a of IRS Form 1099-DIV.Your ordinary dividends include the sum of qualified and nonqualified dividends. , Unlike qualified dividends, nonqualified dividends are taxed at the normal income tax rate.
You will not receive favorable tax treatment for these types of dividends.
Therefore, you can understand your tax liability by simply finding out what tax bracket you are in.
Your income tax bracket can be determined the same way as if you were calculating qualified dividends.
You can do so by calculating your taxable income and matching it up with the applicable tax rate., Nonqualified dividends are reported on line 9a of Form
1040.You can simply copy the number from Form 1099-DIV, box 1a to Form 1040, line 9a. , The IRS will calculate your tax liability based on the information you provide on your Form
1040.
However, if you want to double check, you can look at your 1099-DIV, your tax bracket, and do some simple calculations.
First, subtract the total reported in box 1b of your 1099-DIV from the total reported in box 1a of your 1099-DIV.
This equals the amount of nonqualified dividends you received.
Next, multiply that number by your tax rate.
For example, assume you have ordinary dividends that equal $10,000 (box 1a of your 1099-DIV) and qualified dividends that equal $7,000 (box 1b of your 1099-DIV).
Next, assume you make $50,000 annually in taxable income.
That would put you in the 25% tax bracket (for 2016).
First, subtract $7,000 from $10,000 to get your total nonqualified dividend amount.
This amount would be $3,000.
Next multiply $3,000 by .25, which is your tax rate based on your taxable income.
This would give you $750.
This means you would be taxed $750 on your nonqualified dividends. , When your mutual fund sells a capital asset, in this case stocks or bonds, the difference between the price you paid for the asset and the amount you received after the sale is considered a capital gain or capital loss.For example, assume your mutual fund bought 500 shares of XYZ Corp. for $10,000.
Assume that five years later your mutual fund sold those shares for $17,000.
In this instance, you would have $7,000 in capital gain. , When your mutual fund sends you your 1099-DIV, capital gains are shown in box 2a.The amount shown will be your total capital gains for the year from that mutual fund. , Your capital gains rate will be the same as your qualified dividend rate.
Therefore, you can calculate it the same way.
Determine your normal income tax rate and then look to the IRS to determine the capital gains rate. , When the time comes to report your capital gains to the IRS for tax purposes, you will do so by writing the amount of capital gains in line 13 of Form
1040.
You can get this number by simply looking at box 2a of Form 1099-DIV.
In most cases, you will not be required to do anything else.
However, in some circumstances, you may be required to fill out Form 8949 and/or a Schedule D., While the IRS will calculate your tax liability for you based on what you report on your Form 1040, you can always estimate what your liability will be.
To do so, take the amount in box 2a of your Form 1099-DIV and multiply it by your applicable capital gains rate.
For example, assume you had $20,000 in capital gains in
2016.
This amount was reported in box 2a of your Form 1099-DIV.
You should also assume you make $500,000 in taxable income every year.
This means your income tax rate would be
39.6%.
If your income tax rate is
39.6%, it means your capital gains tax rate would be 20%.
You would then multiply $20,000 by .20 to get your estimated tax liability.
In this scenario, your estimated tax liability would be $4,000. , A prospectus is a document that will provide you with information on the taxation method for that particular mutual fund.
A prospectus will also include information on the terms, conditions, risks, and interest rates for a particular mutual fund.
Contact your financial adviser or investment company to obtain a copy of the prospectus for your mutual fund if needed. , Some mutual funds, such as municipal bonds, are exempt from federal taxes and will not require you to file a 1099-DIV form with the IRS. , These types of mutual funds are managed in a manner that allow the profits and earnings from certain shares offset financial losses you may have experienced in other shares, resulting in overall lower tax liability at the end of the year. , The portfolio of an index fund matches the components of a major stock market index, which generally has a low turnover rate in terms of capital gains.
Low capital gains will often result in much lower distributions and taxation amounts, if at all.
Examples of major stock market indexes are the Standard and Poor's 500, and the Russell
2000. , Most mutual fund distributions are issued in November or December of every year, so if you wait until after the distribution date to buy your shares, you can prevent yourself from having to pay the taxes on those shares immediately.
Check the distribution date of your mutual funds by reviewing the prospectus, or by consulting with your financial adviser or investment company prior to investing.
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Sophia Martin
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