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TAXES
JUNE 1, 2018

Do I Have to Pay Taxes on Mutual Fund Earnings?

Answered by
Nick Giorgi
Investment Strategist, Chief Investment Office
Generally, yes, taxes must be paid on mutual fund gains. Whenever you profit from the sale or exchange of mutual fund shares in a taxable investment account, you may be subject to capital gains tax on the transaction. You may also owe taxes if your mutual fund pays dividends. The amount ultimately depends on the combined total of your gains and losses.
Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
Realizing a capital gain from one mutual fund doesn't guarantee that you'll owe taxes on that gain. "Each dollar of capital loss can potentially offset a dollar of capital gain."
— Nick Giorgi, Investment Strategist in the Chief Investment Office of Bank of America Merrill Lynch

A closer look at capital gains tax

Short-term capital gains are gains from the sale of capital assets held for 12 months or less and are taxed at ordinary income tax rates. Long-term capital gains are gains from the sale of capital assets held for more than 12 months and are currently subject to a federal long-term capital gains tax rate of up to 20%.
Illustration of the difference between short and long term capital gains
But a capital gain in one mutual fund doesn't guarantee that you'll owe taxes on that gain. "Each dollar of capital loss can potentially offset a dollar of capital gain," says Nick Giorgi, Investment Strategist in the Chief Investment Office of Bank of America Merrill Lynch.
For example, if in the same tax year, you have $1,000 in long-term capital gains and $600 in long-term capital losses, you'll pay tax only on the net long-term capital gain of $400. If your capital losses exceed your capital gains for the tax year, you can use up to $3,000 of these excess capital losses to offset ordinary income in such tax year. Excess capital losses over $3,000 can be carried over to offset capital gains in future tax years (and potentially ordinary income up to $3,000 per year).

A quick review of how dividends are taxed

"Qualified dividends," which are dividends that meet several statutory conditions, are generally taxed at preferential, long-term capital gains rates up to a maximum of 20% for high-income investors. Dividends that don't meet the qualified dividend conditions are generally taxed at ordinary income rates.
Taxes are one of many things to consider when it comes to investing in mutual funds. Check out our guide to understanding mutual funds if you're interested in exploring this investment choice further.
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