Bulletins

Year-end Tax Planning for Mutual Fund Investments

by Dennis W. Donnelly, CPA, PFS

To Our Clients and Friends

While mutual funds have certain advantages, they don't always yield the greatest tax results for investors who hold them in taxable accounts. With some advance planning, however, you can achieve better tax outcomes. Around the end of the year - which is where we are right now - the tax planning payoff can be significant.

We won't go into detail about how the mutual fund tax rules work. It's enough to say that they are pretty complicated. Since we want to keep this communication short and to the point, here are three key things to know.

1. If You Are Thinking about Buying into a Fund before Year-end: Check the fund's prospectus or contact the fund before investing to find out when the fund pays dividends. If you buy shares on or before the date of record for an upcoming dividend, you will receive the dividend, and that may increase your 2012 tax bill. If you wait and buy in after the date of record, you won't receive the dividend, and you won't increase your 2012 tax bill.

2. If You Are Thinking about Selling Profitable Fund Shares before Year-end: Check the fund's prospectus or contact the fund before selling to find out when the fund pays dividends. If you sell before the date of record for an upcoming dividend, you won't receive the dividend but your price per share will likely be higher, and that may result in a better tax outcome for you without any loss of cash.

3. Watch out for the Wash Sale Rule When Selling Mutual Funds Shares for a Loss: The wash sale rule prevents you from fully recognizing a tax loss from selling a stock or security if you buy a 'substantially identical' stock or security within the period beginning 30 days before and ending 30 days after the loss sale date. You may be unaware that the wash sale rule applies equally to losses from mutual fund shares and losses from garden-variety stock. In fact, mutual fund investors face a higher risk of running afoul of the wash sale rule, because many investors choose to automatically reinvest mutual fund dividends. When shares in a fund are sold for a loss within 30 days before or after additional shares are acquired via the dividend reinvestment deal, part of the loss will be disallowed for tax purposes under the wash sale rule. The mutual fund wash sale risk is especially acute around the end of the year because that is when you may be thinking about selling loser shares to 'harvest' tax losses, and that is also when many mutual fund dividends are distributed. Please contact us if you have questions about whether the wash sale rule might affect your ability to deduct losses from selling unprofitable mutual fund investments.

Around the end of the year is often when the rubber meets the road tax-wise for individuals with mutual fund investments held in taxable accounts. That time is here. Please contact us if you have questions or want more information.

Very truly yours,

Daniel A. Kosmatka, CPA, PFS, CFF
Dennis W. Donnelly, CPA, PFS
Michael R. Gohde, CPA, PFS