Possible Tax Relief for Mutual Fund Investors

by | Oct 14, 2005 | Weekly Column

Every year at the beginning of tax season, when tax statements are sent to investors, I know that I will be getting a few phone calls from new clients who are not pleased.  They have the following question:  “This form shows that I had a taxable capital gain from the Such-And-Such Fund.  But I didn’t sell my shares in that fund.  Why do I have to pay taxes on this?”

It’s particularly galling for investors to get a year-end statement that shows a taxable capital gain, even though their investment in a fund has declined in value.  It’s possible to lose money on an investment, yet still have to pay capital gains taxes on it.  I just love it when I get to explain that one.

The reason this is possible is that a mutual fund’s overall gains do not necessarily parallel the gains and losses of an individual investor’s shares in that fund.  The fund itself may (in fact, it had better!) earn money over the course of a year.  Its earnings, however, are subject to fluctuations during the year.  Depending on when a particular investor bought shares, that person’s holdings might be worth less at the end of the year than they were when they were purchased.  The mutual fund’s gains for the year, though, are "passed through" to the shareholders on the basis of the proportion of shares they own, without consideration of when the shares were purchased.  The taxable gain shown for each investor isn’t necessarily the same as the actual gain or loss on that person’s shares.

There is a bill pending in Congress that would provide some tax relief for mutual fund investors.  Senate Bill 1740 was introduced this fall by Senators Tim Johnson (D-South Dakota), Mike Crapo (R-Idaho), and Jim Bunning (R-Kentucky).

This measure, along with its companion House Bill 2121, would defer capital gains for investors in mutual funds until the shareholders actually sell their holdings.  This would apply to those who automatically reinvest their earnings, not to those who receive their distributions as income.

The bill, called the Generating Retirement Ownership Through Long-Term Holding (GROWTH) Act, would change the tax code to treat those who invest in mutual funds the same as those who invest in individual stocks.  Its intent is to encourage Americans, particularly small investors, to save more toward retirement.

In a press release about the GROWTH bill, Senator Johnson was quoted as saying, “Private savings are crucial to economic independence at retirement, and mutual funds represent a huge portion of the savings held by American workers.  In South Dakota, there are nearly 267,000 mutual fund shareholders with more than $20 billion in assets.  This bill will encourage workers to automatically reinvest and get workers to think about the long haul by contributing to national savings and building up their own retirement nest egg.”

The bill is currently making its way through both the Senate and the House, having been referred to the Finance Committee in the Senate and the Ways and Means Committee in the House.  For more information on it, you can check out a website maintained by the Library of Congress at www.thomas.loc.gov. Just put in the Senate or House bill number to see the text of the bill and its status.

As a proponent of investing through mutual funds, I am certainly in favor of the GROWTH act.  It will provide some tax relief for mutual fund investors and treat those investors more fairly as compared to individual stock investors.  Of course, my support has nothing to do with the fact that passage of the bill will give me some relief from having to explain those confusing year-end statements.

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