Capital Gain Distributions – Information & FAQs
Capital Gain distribution amounts are based on gains and losses realized through October 31 or the fund’s fiscal year end. Tax adjustments may cause losses to be deferred or may cause unrealized amounts to be treated as realized. Changes in shares outstanding may cause per share amounts to vary. The amount of capital gain distributions will be reported on year-end account statements (mailed in January) and on Form 1099-DIV.
The share price for each fund that distributed capital gains was adjusted downward on the business day following the record date to reflect the amount of the distribution.
Mutual Fund Distributions Frequently Asked Questions
What is a mutual fund distribution (i.e.; capital gain)?
A mutual fund distribution is derived from net capital gains realized from the sale of a fund's investments and income from dividends and interest earned by a fund's holdings less the fund's operating expenses.
Why do mutual funds pay capital gains?
Tax law requires that mutual funds pay substantially all net investment income and net capital gains to their investors, who may elect to receive cash or reinvest in additional shares of the fund.
What are the different types of capital gains distributions made from a mutual fund?
A fund has realized net capital gains when realized gains on the sale of its portfolio assets exceed realized losses. A mutual fund generally does not pay taxes on realized net capital gains, but instead distributes these gains to shareholders who then include them on their individual income tax returns. These gains are classified as long or short-term gains and are taxed differently. A gain on the sale of an investment owned for one year or less is considered short-term for federal income tax purposes and is taxed as ordinary income. A gain on the sale of an investment owned for more than one year is considered long term for federal income tax purposes.
Are capital gains distributions involving certain asset classes treated differently for federal tax purposes?
Yes, gains from the sale of certain commodities such as gold bullion are taxed at a 28 percent rate regardless of the taxpayer’s federal income tax bracket. Also, certain real estate-related capital gains distributions from the sale of property held by real estate investment trusts within a mutual fund may be reported later than other distributions typically reported on IRS Form 1099-DIV.
What are the tax implications of distributions to shareholders?
Shareholders -- except those in tax-sheltered accounts such as Individual Retirement and 401(k) and 403(b) accounts -- are required to pay taxes on distributions, whether the distributions are paid out in cash or reinvested in additional shares. Long-term capital gain distributions are taxed at long-term capital gains tax rates; distributions from short-term capital gains and net investment income (interest and dividends) are taxed as dividends at ordinary income tax rates. Ordinary income tax rates generally are higher than long-term capital gains tax rates.
How does a mutual fund generate income and capital gains to be distributed?
A mutual fund generates capital gains and income for shareholders in two ways -- by selling investments that have increased in value and by earning dividends and interest on its investments.
What types of distributions do mutual funds make?
Long-term capital gain distributions, which are the net long-term gains realized from the sale of securities. Capital gain distributions come from long-term gains resulting from the sale of securities held for more than one year and are taxed at long-term capital gains tax rates.
Ordinary dividends, which are derived from (1) dividends or interest the fund earns on its investments and (2) net realized short-term gains from selling securities held one year or less. These are taxed at ordinary income rates. (NOTE: Unrealized gains on investments that have increased in value but have not yet been sold are reflected daily as part of a fund's net asset value.)
Is a fund's share price affected when a distribution is paid?
Does a fund's distribution affect its total return?
How is a mutual fund affected if there is no required distribution?
There are no tax consequences to shareholders or to the fund if a distribution is not required. The fund's net asset value and its investment performance would remain the same. Shareholders will not be required to pay taxes if the fund has not made a taxable distribution.
Who is responsible for paying taxes on these distributions?
Shareholders are responsible for paying taxes on distributions they receive each year, whether they receive the distributions in cash or reinvest them in additional shares of the fund. The funds report distributions to shareholders on IRS Form 1099-DIV at the end of each calendar year. Certain types of fund accounts, such as Individual Retirement and 401(k) accounts, are tax-advantaged. Therefore, shareholders who own these types of accounts pay taxes, if any, on fund distributions only when money is withdrawn from the account and will receive different IRS reports.
How is distribution eligibility determined?
Record Date: All shareholders of record at close of business on this day are eligible to receive the distribution.
Ex-Dividend Date: The date on which the distribution amount per share is deducted from the fund's net asset value per share. The ex-dividend date is generally the business day after the record date.
Payment Date: The fund pays customers their proportional shares of the distribution on this date. For Waddell & Reed funds, the payment date for distributions paid in cash is normally the same business as the ex-dividend date, except for those funds with daily income distributions. Shares purchased with reinvested distributions usually are credited on the reinvestment date at the fund's net asset value (NAV) for that date.
Do fund managers try to limit capital gain distributions?
Our basic buy and hold philosophy helps limit the amount of gains realized in any period. However, while taxes are an important consideration, securities will be sold when it is appropriate for investment reasons.
Since the cutoff for distributions is October 31st, if gains are realized after this date, when are they distributed to shareholders?
Any gains or losses realized in November or December will be included with the distributions for the following year.
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This information is provided for informational and educational purposes only and may include references to concepts that have legal, accounting and tax implications. It is not to be construed as legal, accounting or tax advice, and is provided as general information to assist in understanding the issues discussed. Waddell & Reed does not provide tax advice. Waddell & Reed believes the information has been obtained from sources considered to be reliable, but does not guarantee the accuracy of the information provided.