As investors of various mutual funds file their tax returns for the year 2011 , any hopes that the complexity with which the funds are handled and the confusion they create around themselves , should be given up .
An increase in capital gains is very likely next year and would add additional grievances to the insulting fashion in which the taxes are calculated on the funds.
The present issue that is bugging is that mutual funds act as pass-through obligations where by investors who are holding them in taxable accounts have to calculate taxes on them every year based on the trading activity within the fund .
The situations which mulls confusion is that when investors buying a fund which has had taxable gains are having to pay even if they haven’t had the share in the profits . Also what is hard to explain is that how the funds despite losing money in the year are generating tax bills with gains being locked by the managers in an overall declining market.
The perplexity can be eliminated by allowing the investors to pay taxes on the basis of when they buy and sell . This would encourage long-term investments in these funds.
In stock options , an investors will owe capital gains only if he is selling shares at a profit . A similar model is followed for exchange-traded funds , funds built to trade viz-a-viz the stocks. Their structure allows the investor to use inflows and redemption to zero out a portfolios’ capital gains and they avoid the interim taxes , facing taxes only if they sell at a profit.
That is also the procedure that is followed for mutual funds for normal investors in most of the countries. But in the U.S the structure somehow manages to be worse than it is outside .
According to a study by the Investment Company Institute , the issue is affecting nearly 90 million investors with a taxable accounts worth $4 trillion in the last year .
Beside the risk of losing money , the investors are sometimes having to face the scenario of having to pay the taxes twice . After paying the taxes on the distributions during the financial year if they fail to adjust cost basis while rolling back the dividends into the fund , they end up paying taxes on the distribution twice.
According to the new rules , fund companies need to keep a record of the shareholder’s cost but only for purchases this year . The investors therefore might find it hard to keep a track of their earlier investments , making it likely that the cost basis numbers might not get adjusted properly to reflect the distributions received , taxed, and reinvested.