If they are deductible, investment expenses other than investment interest are taken as miscellaneous deductions on Form 1040, Schedule A (PDF), Itemized Deductions. These deductions must be reduced by 2% of your adjusted gross income.

Commissions and fees for the acquisition or sale of an asset are added to the basis of that asset and are not deductible. For example, acquisition fees, sales commissions, and load charges paid in connection with the purchase or selling of mutual fund shares are not deductible. They can usually be added to the basis of the shares.

Fees for managing investments, such as custodial fees and management fees, are deductible. Fees you pay a broker to collect taxable bond interest or stock dividends are deductible. Fees that pass through to you from non-publicly offered mutual funds, partnerships, or trusts are deductible. All of these fees are subject to the 2% limit. For more information, refer to Publication 529, Miscellaneous Deductions; Publication 550, Investment Income and Expenses; and Publication 564, Mutual Fund Distributions.

References:

• Publication 17, Your Federal Income Tax for Individuals
• Publication 529, Miscellaneous Deductions
• Publication 550, Investment Income and Expenses
• Publication 564, Mutual Fund Distributions

Enter the ordinary dividends from Form 1099DIV (PDF), box 1, on line 9 of Form 1040 (PDF), U.S. Individual Income Tax Return. Enter the total capital gain distributions from box 2a on line 13, column (f) of Form 1040, Schedule D (PDF). Enter the 28% rate gain portion of your capital gain distributions from box 2b on line 13, column (g) of Schedule D. If you have an amount in box 2c or box 2d, refer to Instructions for Form 1040, Schedule D. Nontaxable distributions, box 3, that are return of capital distributions, reduce your cost basis and are not taxable until your basis is reduced to zero. If no amount is shown in boxes 2b through 2d, and your only capital gains and losses are capital gain distributions, refer to Instructions for Form 1040 for line 13.

References:

• Form 1040, Schedule D (PDF), Capital Gains and Losses
• Instructions for Form 1040
• Instructions for Form 1040, Schedule D

You do not have to make estimated tax payments until you receive income on which you will owe the tax. Since your mutual fund distributions are not made until the last quarter of the year, you need only make an estimated tax payment for the last quarter by January 15th. However, even if you make an adequate payment of tax by January 15th, you should also complete Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts, and attach it to your income tax return when you file, you may be assessed an estimated tax penalty by the IRS service center when your return is processed, otherwise because estimated tax payments are normally made in four equal installments and the IRS will not know your liability occurred in the fourth quarter. You should check the box on the front page of the Form 2210 to select the Annualized Income Installment method, and then complete Schedule AI on page 3. When you compute the penalty on page 2 of that form using the numbers from Schedule AI, your penalty will be $0 if you made an adequate payment. Even if you did not make the January 15th payment, or made an inadequate payment, the annualized income method on Form 2210 may significantly reduce the estimated tax penalty.

References:

• Publication 505, Tax Withholding and Estimated Tax
• Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts

If the $7,000 in tax is a result of a distribution not covered by prepayments of tax, either through income tax withholding or estimated tax payments, you should make an estimated tax payment by January 15th of the next year. If you wait to pay the $7,000 with your return, you may be penalized for an underpayment of estimated taxes. Even if you make an adequate payment of tax by January 15th, you may be assessed an estimated tax penalty by the IRS service center when your return is processed unless you file Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts . This is because estimated tax payments are normally made in four equal installments and the IRS will not know your liability occurred in the fourth quarter unless you explained when the income was received.

You may be subject to the penalty if you owe at least $1,000 in tax after subtracting your withholding and credits from your tax liability, and you did not prepay at least 90% of your current year's tax or 100% of your previous year's tax. (The latter percentage is higher for higher (110 %) ($75,000 if MFS) income taxpayers with adjusted gross incomes from the previous year of more than $150,000.)

If you make an adequate payment by January 15th but made no earlier estimated tax payments, use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts, to compute your penalty. Check the box on the front page selecting the Annualized Income Installment method, and then complete Schedule AI on page 3. When you compute the penalty on page 2 of that form using the numbers from Schedule AI, your penalty will be $0 if you made an adequate payment. Even if you did not make the January 15th payment or made an adequate payment, the annualized income method on Form 2210 may significantly reduce the estimated tax penalty.

For more information on estimated tax payments and the underpayment of estimated tax penalty, refer to Publication 505, Tax Withholding and Estimated Tax.

References:

• Publication 505, Tax Withholding and Estimated Tax
• Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts

You would have to report any capital gains realized on the sale. Even assuming this transaction meets the requirements of an exchange, rather than a sale, the exchange of shares of one fund for those of another is a taxable exchange. This is true even if both funds are within the same family of funds.

References:

• Publication 564, Mutual Fund Distributions

If a child is 14 years old or older and has a requirement to file an income tax return, he or she would report dividends and capital gains no differently than any other taxpayer. If the child is under age 14 and his or her only income is from interest and dividends (including capital gain distributions), the child's parents can make an election to include the income on the parent's return. If the parents make this election, then the child does not have to file a return. The election is made on Form 8814 (PDF), Parent's Election To Report Child's Interest and Dividends.

In order to make the election under Form 8814,

If a child under the age of 14 has investment income and the parents do not make the above election, the child reports the income as any other taxpayer would. Special rules on how the investment income is taxed, however, may apply. A child under the age of 14 with investment income (interest, dividends, capital gains, etc.) of more than $1,500 may be subject to the parents' tax rate. The special tax computation is figured on Form 8615 (PDF), Tax for Children Under Age 14 Who Have Investment Income of More Than $1,500.

For more information, refer to Publication 929, Tax Rules for Children and Dependents

References:

• Form 8814 (PDF), Parent's Election To Report Child's Interest and Dividends
• Form 8615 (PDF), Tax for Children Under Age 14 Who Have Investment Income of More Than $1,400
• Publication 929, Tax Rules for Children and Dependents

Yes, you report the sale of your shares on Form 1040, Schedule D (PDF), Capital Gains and Losses. Generally, whenever you sell, exchange, or otherwise dispose of a capital asset, you report it on Schedule D.

If the share price were constant, you would have neither a gain nor a loss when you sell shares because you are selling the shares for the same price you purchased them.

If you actually owned shares that were later sold, the fund or the broker should have issued a Form 1099-B There is no requirement with that form that there be gain or loss on the sale, only a sale or exchange of an investment asset and sales proceeds.

References:

• Publication 564, Mutual Fund Distributions

You need to reconstruct your records the best that you can. Contact your broker or the mutual fund company for assistance.

Another source of information is your prior year tax returns. If your mutual fund has been reinvesting dividends, those reinvested dividends (which have been used to purchase additional shares in the fund) should have been reported as dividend income on your tax return each year. To compute your total basis, add to the cost of the original shares purchased the amount of all dividends automatically reinvested that were previously reported as income on your prior tax returns and any shares you subsequently purchased.

You can usually also add acquisition fees and load charges you've paid to your basis in your mutual fund shares. If you sell your shares and the sales commission is not subtracted from the sales proceeds on Form 1099-B, Broker and Barter Exchanges, you can add the commission to the basis of the shares sold. If you receive a distribution that is identified as a return of capital, you must reduce your total basis by that amount.

Refer to Keeping Track of Your Basis in Publication 564, Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions

Unless you have acquired shares through gifts or inheritances, your basis is what the shares cost you. Your mutual fund company can often provide you with this information upon request. Another source of information is your broker, if the fund was purchased through a broker. You cannot calculate your basis in your mutual fund shares accurately without this information. You can only claim the amount of basis that you can establish and substantiate with records. You may lose a large part of your basis if you cannot establish the amount of dividends that were reinvested. This is why keeping records is so important.

Another source of information on reinvested dividends is your prior year tax returns. If your mutual fund has been reinvesting dividends, those reinvested dividends should have been reported as dividend income on your tax return each year.

For more information, refer to Publication 564, Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions

They would affect your total basis and total number of shares if they were reinvested in the mutual fund. Add the reinvested dividends and capital gains that you have reported as income on your tax return to your total basis. You will also own additional shares in the fund because the dividends and capital gains have been used to purchase shares. Keep good records. If you are going to be using an average basis method to determine per-share basis on sales, be sure and keep records of all your mutual fund activity until you no longer own any shares in that fund.

There is a worksheet to help you keep track of your number of shares and your basis in Publication 564, Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions

A return of principal (or return of capital) reduces your basis in your mutual fund shares. Unlike a dividend or a capital gain distribution, a return of capital is a return of part of your investment (cost). However, basis cannot be reduced below zero. Once your basis reaches zero, any return of principal is capital gain and must be reported on Form 1040 Schedule D (PDF), Capital Gains and Losses.

References:

• Publication 564, Mutual Fund Distributions

You are referring to meeting the requirement for "adequate identification." If you can definitively identify the shares sold, you do not need to use the adequate identification rules. You can use the adjusted basis of those particular shares to figure your gain or loss.

The "adequate identification" rules allow you to control which shares are considered sold, even though you may not control which shares are actually sold. If you specify to your broker which shares you want sold prior to or at the time of the sale and they confirm within a reasonable time in writing, then you are considered to be able to "adequately identify" the shares sold, even if the broker actually sells different shares. The confirmation by the mutual fund must be given to you within a reasonable period of time and state that you instructed the broker to sell particular shares.

If you cannot identify the specific shares and you do not want to use an average basis, then you must use the first-in first-out method (FIFO). These two methods are both cost basis methods. You may not use either cost basis method if you have previously used an average basis method for that mutual fund on a tax return. Refer to Publication 564, Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions

No. If you subsequently sell some shares in that mutual fund and can identify the shares sold, you can switch to the specific share identification method. Both of these methods are cost basis methods.

To switch to an average basis method, you must have acquired the shares at various times and prices, and left the shares on deposit in an account handled by a custodian or agent who acquires or redeems those shares. Once you elect to use an average basis method, you must continue to use it for all accounts in the same fund. However, you may use a different method for shares in other funds, even those within the same family of funds.

Before using an average basis, be sure your records reflect the disposition of the shares that were reported using the cost basis method (FIFO).

References:

• Publication 564, Mutual Fund Distributions

Yes, you can. The only requirement for using an average basis is that you acquired the shares at various times and prices, and you left the shares on deposit in an account handled by a custodian or agent who acquires or redeems those shares. An average basis method, once adopted, must be disclosed on your tax return and the method cannot be changed back without permission from the Commissioner of the Internal Revenue Service.

Before computing the basis of shares sold using an average basis, ensure that you have reduced your previous total basis by the cost of the shares accounted for using the FIFO method.

References:

• Publication 564, Mutual Fund Distributions

Yes. You would include in your average basis calculations only those shares that were still held at the time of the sale you are reporting.

References:

• Publication 564, Mutual Fund Distributions

In order to figure your gain or loss using an average basis, you must have acquired the shares at various times and prices and have left them on deposit in a managed account.

There are two average basis methods:

Single-category method. First, add up the cost of all the shares you own in the mutual fund. Divide that result by the total number of shares you own. This gives you your average per share. Multiply that number by the number of shares sold.

Double-category method. First, divide your shares into two categories, long-term and short-term. Then use the steps above to get an average basis for each category. The average basis for that category is then the basis of each share in the sale from that category.

Once you elect to use an average basis method, you must continue to use it for all accounts in the same fund. You must clearly identify on your tax return the average basis method that you have elected to use. You do this identification by including "AVGB" in column (a) of Form 1040, Schedule D (PDF) .

Refer to Publication 564 , Mutual Fund Distributions, Sales, Exchanges and Redemptions .

References:

• Publication 564, Mutual Fund Distributions
• Instructions for Form 1040, Schedule D

If you are electing or have previously elected to use the double-category method for that mutual fund, you need to do two separate computations; one for long-term and one for short-term-only. The single-category method requires only one computation of average basis.

For more information, refer to Publication 564, Mutual Fund Distributions, Sales, Exchanges, and Redemptions.

References:

• Publication 564, Mutual Fund Distributions

Either write the name of the average basis method used as a notation on Form 1040, Schedule D (PDF), Capital Gains and Losses , or attach a sheet to the Schedule D showing in detail how you computed the basis of the shares sold. Whenever you attach a statement to your return, include your name(s) and social security number(s). Also include "AVGB" in column (a) of Schedule D.

References:

• Publication 564, Mutual Fund Distributions
• Instructions for Form 1040, Schedule D

No, you may use a different method, as long as you have not used an average basis method for that fund previously. Once you have elected to use an average basis method to compute the gain or loss on shares in a mutual fund, you must use that same method for the sale of shares from any account in that same fund.

References:

• Publication 564, Mutual Fund Distributions

How you determine the holding period of mutual fund shares you sold depends on which of the two average basis methods you are electing to use. Once you have elected a method, you must use that method for determining the basis of any shares sold in the future from that fund.

You may specify top your broker the category from which the deemed shares are sold. Shares will be deemed sold from that category so long as your broker provides you with confirmation of the sale. If you do not specify or if the broker fails to provide confirmation shares will be deemed sold first from the long-term category.

References:

• Publication 564, Mutual Fund Distributions

If you used the single-category method, the average per-share basis is the same for the shares you still hold as the ones you sold. The next time you sell shares, the per-share basis will remain the same unless you acquired additional shares in the meantime.

If you subsequently sell some shares and have acquired additional shares since the last sale, you recompute the average basis. Divide the total cost of the shares that you hold at the time of sale by the number of shares you hold at the time of sale.

If you previously used the double-category method to compute an average basis, you need to transfer from the short-term category to the long-term category any shares that have been held longer than one year at the time of a subsequent sale. Transfer the shares at the per-share basis for the short-term category computed at the time of the last sale, then recompute the average basis for the two categories. Use the new total cost and total number of shares for each category.

For more information, refer to Publication 564, Mutual Funds.

References:

• Publication 564, Mutual Fund Distributions

If your mutual fund splits, or adjusts its price, it is treated like a stock split. Your total basis doesn't change after the split, but since you now own more shares without paying any more money, your per-share basis will decrease. To calculate your per-share basis, divide the total cost that you have invested in the fund (minus any shares previously sold) by the current number of shares that you hold.

References:

• Publication 564, Mutual Fund Distributions

If a stock within your mutual fund splits, it has no affect on your basis because the shares you own are shares in the mutual fund, not in the stock that split.

References:

• Publication 564, Mutual Fund Distributions

You do not need permission to elect an average basis method for a particular mutual fund when you have used a cost basis previously to report the sale of shares in the fund. If you meet the conditions to use an average basis, then you just need to clearly indicate on the return for which you want the election to be in effect that you are making the election. You also need to indicate which average basis method you are using and that none of the shares are gift shares. If there are gift shares in the account and the fair market value of the shares at the time of the gift was not more than the donor's basis, you must include a statement that the basis for gift shares when figuring the average basis is the fair market value at the time of the gift.

If you have already reported the sale using a cost basis, you cannot make this election unless you can do it on an amended return before the due date of the tax return being amended.

However, you do need the consent of the IRS to use a cost basis or to change your average basis method once you have made this election to use an average basis method. This would be considered a change in an accounting method. You would need to request consent to change your method on Form 3115 (PDF), Application for Change in Accounting Method.

For more information, refer to Publication 564, Mutual Fund Distributions, Publication 538, Accounting Periods and Methods, Instructions for Form 3115, Application for Change in Accounting Method, Revenue Procedure 97-27, and Section 9.03 of Revenue Procedure 2003-1.

References:

• Publication 538, Accounting Periods and Methods
• Publication 564, Mutual Fund Distributions
• Form 3115 (PDF), Application for Change in Accounting Method
• Instructions for Form 3115, Application for Change in Accounting Method

A mutual fund is a regulated investment company that pools funds of investors allowing them to take advantage of a diversity of investments and professional asset management. You own shares in the fund, but the fund owns assets such as shares of stock, corporate bonds, government obligations, etc. One of the ways the fund makes money for its investors is to sell these assets at a gain. If the asset was held by the mutual fund for more than one year, the nature of the income is capital gain, which gets passed on to you. These are called capital gain distributions, which are distinguished on Form 1099DIV (PDF) , from income that is from other profits, called ordinary dividends.

Capital gains distribution are taxed as long term capital gains regardless of how long you have owned the shares in the mutual fund. If your capital gains distribution is automatically reinvested, the reinvested amount is the basis of the additional shares purchased.

References:

• Publication 564, Mutual Fund Distributions

Capital gain distributions from a mutual fund are by definition long-term. That's why they appear only in Part II of Form 1040, Schedule D (PDF), Capital Gains and Losses. The annual statement you receive from your mutual fund may list short-term capital gains, but your Form 1099-DIV will show those amounts as ordinary dividends in box 1a.

Ordinary dividends (which include the mutual fund's profits from short term capital gains) are reported on Form 1040, Schedule B (PDF), Interest & Dividend Income , or Form 1040A, Schedule 1 (PDF), Interest and Ordinary Dividends, if the total is over $1500. In addition, you enter the total ordinary dividends on line 9a of Form 1040 or line 9a of Form 1040A.

The 2003 Form 1099-DIV has added box 1b "Qualified Dividends." This box shows the portion of the amount in box 1a may be eligible for the new 15% or 5% capital gains rates. See the instructions for Form 1040/1040A for how to determine the eligible amount and report this amount on line 9b of your Form 1040 or 1040A .

Refer to the line 13 instructions of Form 1040 for exceptions when you can enter capital gain distributions directly on line 13 of Form 1040 without having to file Schedule D.

References:

• Publication 564, Mutual Fund Distributions

Your Form 1099-DIV is correct, but so is your annual statement. For the purpose of reporting taxable income on your tax return, capital gain distributions are defined as long-term capital gains only. Short-term capital gains are taxed as ordinary income and are therefore treated as ordinary dividends on Form 1099DIV (PDF) .

Box 1b of your Form 1099-DIV shows the portion of the amount in box 1a that may be eligible for the new 15% or 5% capital gain rates. See the Instructions for Form 1040 and Instructions for Form 1040A for how to determine the eligible amount and report this amount on line 9b of your, Form 1040 (PDF) Form 1040A (PDF) .

The short-term capital gains will be in box 1a "ordinary dividends" on 1099-DIV. These will be reported on line 9a of 1040/1040A.

Report the fund's short-term capital gains as part of your total ordinary dividends on line 9 of your Form 1040 or 1040A. (You may have to also report them on Form 1040, Schedule B (PDF), Interest & Dividend Income or Form 1040A, Schedule 1 (PDF), Interest and Ordinary Dividends . Refer to the instructions to the schedule.)

References:

• Publication 564, Mutual Fund Distributions

You cannot. You did not sell the assets that produced this income, the mutual fund did. All income that is taxed as ordinary income flows through to you as ordinary dividends, whether the income is from interest, dividends, or the sales of short-term capital assets.

In the same manner, you report capital gain distributions as long-term capital gains on your return regardless of how long you have owned the shares in the mutual fund. This is because the asset was held and then sold by, the mutual fund, not by you.

Report your total ordinary dividends (including the short-term capital gains in your mutual fund) on Form 1040, line 9a, or Form 1040A, line 9a, with your other ordinary dividends, if any. You may also have to file Form 1040, Schedule B (PDF) , Interest & Dividend Income or Form 1040A, Schedule 1 (PDF), Interest and Ordinary Dividends.

References:

• Tax Topic 409, Capital gains and losses
• Publication 550, Investment Income and Expenses

Only the capital gain distributions are reported on Form 1040, Schedule D (PDF), Capital Gains and Losses . They are reported in Part II as long-term capital gains. Short-term capital gains are taxed as ordinary income and are therefore treated as ordinary dividends on Form 1099-DIV. They are reported on line 9a of Form 1040 (PDF) or Form 1040A (PDF).

Because many mutual fund companies send out annual fund statements as well as Forms 1099-DIV, or "consolidated statements," some confusion has arisen regarding short-term capital gains. The purpose of Form 1099-DIV is to provide you with information to report income correctly on your tax return.

The annual report often breaks down the income from fund activity as dividends, tax-exempt dividends, short-term capital gains, long-term capital gains, returns of capital, and undistributed capital gains. Form 1099-DIV, on the other hand, will show only ordinary dividends (which includes the fund's short-term capital gains), capital gain distributions, and returns of capital (nontaxable distributions), and qualified dividends.

Mutual fund companies may combine the annual fund information with the Form 1099-DIV information into a consolidated statement. If this is what you receive, look for the part of the statement identified as the Form 1099-DIV or that contains language such as "in lieu of Form 1099-DIV."

References:

• Tax Topic 409, Capital gains and losses
• Publication 564, Mutual Fund Distributions

No. The kind of income the assets in the fund earn is tax-free. When you sell your shares in the fund, a taxable gain or deductible loss is realized on the sale. This is the true also for the sale of tax-exempt securities such as municipal bonds.

References:

• Tax Topic 409, Capital gains and losses
• Publication 564, Mutual Funds Distribution

If the $7,000 in tax is a result of a distribution not covered by prepayments of tax, either through income tax withholding or estimated tax payments, you should make an estimated tax payment by January 15th of the next year. If you wait to pay the $7,000 with your return, you may be penalized for an underpayment of estimated taxes. Even if you make an adequate payment of tax by January 15th, you may be assessed an estimated tax penalty by the IRS service center when your return is processed. This is because estimated tax payments are normally made in four equal installments and the IRS will not know your liability occurred in the fourth quarter unless you file Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts.

You may be subject to the penalty if you owe at least $1,000 in tax after subtracting your withholding from your estimated tax liability, and you did not prepay at least 90% of your current year's tax or an amount equal to 100% of your previous year's tax. (The latter percentage is higher for higher-income taxpayers with adjusted gross incomes from the previous year of more than $150,000.)

If you make an adequate payment by January 15th but made no earlier estimated tax payments, use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts, to compute your penalty. Check the box on the front page selecting the Annualized Income Installment method, and then complete Schedule AI on page 3. When you compute the penalty on page 2 of that form using the numbers from Schedule AI, your penalty will be $0. Even if you did not make the January 15th payment, the annualized income method on Form 2210 may significantly reduce the estimated tax penalty if the income for which there was no prepayment of tax was earned in the third or fourth quarters of the year.

For more information on estimated tax payments and the underpayment of estimated tax penalty, refer to Publication 505, Tax Withholding and Estimated Tax.

References:

• Publication 505, Tax Withholding and Estimated Tax
• Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts