Mutual Fund Shares Taxation
How is a mutual fund taxed?
A mutual fund generally does not pay taxes if it complies with certain provisions under the Internal Revenue Code, including satisfying income, diversication, and distribution requirements.
How is a mutual fund shareholder taxed?
A shareholder that owns a mutual fund in a taxable account may be subject to tax on earnings generated in two ways. First, if a shareholder receives distributions from a fund, a portion or all of the distributions received may be subject to income tax. Second, shareholders that sell their shares of a fund and realize gains on the disposition of fund shares may also be subject to income taxation.
Please see below for more details on how mutual fund distributions and proceeds from the sale of mutual fund shares are taxed.
Tips to Reduce Your Tax Bill
What is your purpose for saving?
If you are saving for a specific event, such as retirement or your child's education, be sure to maximize your tax-deferred options before investing in a taxable account. (See our Retirement Center for details.)
How can I reduce my tax bill?
Holding a mutual fund in a taxable account will have income tax implications. However, there are various techniques that may be useful in attempting to reduce your tax bill due to mutual fund investments.
Time your purchases properly
A mutual fund generally distributes all of the income it earns in the year which it is earned. Prior to such distribution, a fund's undistributed income and undistributed net realized gains are part of its net asset value (""NAV""). Once the undistributed amounts are paid by a fund in the form of a dividend, a fund's NAV is decreased by that amount. If you purchase fund shares just prior to a fund paying a dividend, you may be ""buying a dividend."" This means that a fund will distribute to you a dividend that generally is taxable; however, since you were not a shareholder at the time the fund earned the income, such distribution is essentially a taxable return of your investment.
Be mindful of holding periods
The differential between the maximum long-term and short-term tax rates is currently 20%. Prior to disposing a fund at a gain, consider whether you have met the long-term holding period. If your holding period is one year or less, you may want to factor in the additional tax implications of a short-term holding period. A buy and hold strategy typically produces the most tax-efficient result.
Have you considered municipal bond funds?
Dividends from a municipal bond fund generally are exempt from federal income taxes; therefore, depending on your income tax bracket, they may produce a higher after tax yield than some taxable income funds. However, you should understand that the income derived from a municipal bond may be subject to the alternative minimum tax and state and local taxes may apply. Also , in rare cases, a municipal bond may be reclassified by the IRS as taxable, therefore creating taxable rather than tax-free income.
Sale of Mutual Fund Shares
What about dividends being reinvested?
By electing to reinvest your dividends, you are instructing the fund to purchase additional shares with the dividend instead of receiving the dividend in cash. The holding period for the additional shares purchased by using the dividend generally begins on the date after the reinvestment.
What types of transactions would generate a realized capital gain or loss?
The sale or redemption of fund shares would generally trigger a taxable event. Sales also include participation in systematic withdrawal plans. The exchange of one fund for another fund also would trigger a taxable event because an exchange is similar to selling one fund and using the proceeds to purchase shares of a new fund.
How are gains or losses on the sale of fund shares computed?
In order to determine the gain or loss on the disposition of fund shares, you must compare the amount you realized (generally the net proceeds) to the adjusted cost basis (generally the amount you paid adjusted accordingly). If the amount you realized is more than the adjusted cost basis, you have a gain. If the amount you realized is less than the adjusted cost basis, you have a loss.
What is the difference between long-term and short-term capital gains?
Short and long-term relate to the length of time you hold a fund. Generally, if you hold a fund for more than one year from the purchase date to the sale date, the gain or loss on this transaction will be considered long-term. Fund shares held for one year or less are considered short-term. Long-term gains are typically taxed at a lower rate than short term gains. Currently the maximum long term rate is 15%.
How is the holding period determined?
Generally, the holding period of a fund share begins the day after you purchase a fund and ends on the date the fund shares are sold. It is possible that shares of the same fund have been purchased at different times; therefore, a portion of your holdings of a fund may produce long-term gains (losses) and a portion may produce short-term gains (losses). To determine how long you held your shares, begin counting on the day after the trade date on which you bought the shares (do not include the trade date itself). The trade date on which you sold the shares is counted as part of your holding period.
If I exchange one fund for another fund within the same fund family, is that a taxable transaction?
Yes. Each fund is considered a separate company for tax purposes; therefore, if you exchange out of one fund and into another, the transaction will be treated as if you sold shares in one company and purchased another, causing the transaction to be taxable. It should be noted that if you originally bought a fund with a sales charge, then exchange out of that fund and into another fund in the same fund family within 90 days, and the sales charge is waived for exchanges, you may not be able to take into account the sales charge paid in determining your gain or loss due to the exchange. The sales charge paid is generally added to the cost of the new fund. (See IRS Publication 550 for additional details.)
Mutual Fund Distributions
What is the source of a mutual fund's income?
Mutual funds generate gains by selling investments that have increased in value. They also generate income by receiving dividends and accruing interest, net of expenses, on securities held within the portfolio. All income and capital gains earned by a mutual fund are required to be distributed to shareholders of the fund in the form of a dividend in order for the mutual fund to avoid paying corporate level taxes. The shareholders who receive the dividend pay taxes on the amount of dividends they receive.
Are all ordinary income distributions qualified dividends and, therefore, subject to the reduced maximum tax rate of 15%?
No. In general, the maximum amount of qualified dividends a fund can pass through to its shareholders is limited to the amount of qualified dividend income the fund received. If a fund earned income from interest, short-term capital gains, currency gains, certain foreign companies, or other nonqualifying sources, then a portion of a fund's ordinary income distribution may not be a qualified dividend. Nonqualified dividends are subject to ordinary income tax rates.
Are my reinvested dividends taxable?
Yes. A dividend received in cash or reinvested will be taxable to the shareholder. If a dividend is reinvested, it is similar to a shareholder receiving the dividend in cash and automatically reinvesting it into a fund. The reinvestment of a dividend is deemed to be a purchase of additional shares in a fund.
Are long-term capital gain distributions considered long term if I held the fund for less than one year?
Yes. Long-term capital gain distributions are always considered long term, regardless of how long you held the fund. There is no holding period requirement in order to take advantage of the lower tax rate afforded to long-term capital gain distributions.
Why do mutual funds pay dividends?
Each mutual fund is treated by the Internal Revenue Code as a separate corporation for tax purposes. However, unlike a regular corporation that is subject to "double taxation" (taxed once on earnings generated at the corporate level and again on dividends paid relating to the same earnings at the shareholder level), mutual funds may "pass through" income earned to their shareholders without paying corporate level taxes. In order to avoid corporate level taxes, a mutual fund must meet certain IRC requirements. One of these requirements is that the mutual fund must distribute substantially all the income it earns to its shareholders in the year which it is earned.
What kinds of distributions are paid by a mutual fund?
In order to preserve some of the tax characteristics of the income as generated by the fund, a fund may pay different kinds of distributions. The most common are listed below:
Long-term capital gain distributions – Net gains on securities held for more than one year are considered long-term. Long-term capital gains are currently taxed at the maximum tax rate of 15%.
Ordinary income distributions – Net investment income (dividends and interest less expenses), short-term capital gains (securities held for one year or less), and various other types of gains are considered ordinary income. Ordinary income distributions generally are taxable to the shareholder at the ordinary income tax rates.
Tax-exempt distributions – If a fund invests primarily in direct municipal obligations, it may deem all or a portion of its net investment income distributions exempt from federal income taxes.
Return of capital – A distribution made by a fund in excess of its earnings and profits for tax purposes will be considered a tax return of capital. A return of capital is generally not taxable to the shareholder and reduces the shareholder's adjusted basis (not below zero) in a fund.
What is a "qualified dividend"?
A qualified dividend is a dividend paid by certain U.S. corporations or qualified foreign corporations. A mutual fund is able to pass through those qualified dividends to its shareholders, provided that the mutual fund has satisfied certain holding period requirements. If the conditions are satisfied, the maximum tax rate for qualified dividends is 15%. The portion of the ordinary income dividends paid to you that is eligible for the reduced tax rate will be provided on Form 1099-DIV. To benefit from the lower tax rate on qualified dividends, you generally must have held your shares in the mutual fund for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date.
Are all ordinary income dividends taxed at the same rate?
Ordinary income dividends are taxed at the shareholder's ordinary income rate, which is currently as high as 35%. If a fund receives qualified dividends (i.e., a dividend paid by certain U.S. corporations or qualified foreign corporations) and passes through those dividends to its shareholders, the maximum income tax rate is 15% if certain conditions are met. Qualified dividends are explained more fully below.
Cost Basis of Investment
How is the adjusted cost basis computed?
In order to compute the adjusted cost basis, you must first determine the original cost. The original cost is the purchase price of the shares plus any commission or load charges paid. The original cost basis may then need to be adjusted by certain items, the most common of which is a return of capital paid by the fund. If a fund pays a return of capital, also known as a nondividend distribution, the original cost basis should be reduced (but not below zero) by the amount of return of capital received. It should be noted that shares acquired by gift, inheritance, or other particular acquisitions have other special rules to determine the adjusted cost basis.
Which method of disposing shares is better?
The specific identification method of selecting shares gives you the most flexibility with regards to tax planning. For example, you may want to generate some losses to offset gains produced from the sale of another security. If you hold a fund that was purchased numerous times at different prices, you have the ability to choose the lots that would generate a loss. One potential disadvantage of using the specific identification method is the time and effort that is needed in order to properly track each lot separately. The average cost method may be the easiest method to use because most fund families will compute your gain or loss on the sale of shares as a service to fund shareholders.
Are all dispositions of fund shares that are held for one year or less considered short-term capital losses?
No. If you received a long-term capital gain dividend and sold your shares at a loss and your holding period was six months or less, the short-term capital loss will be considered a long-term capital loss to the extent of long-term capital gain dividends received.
Do I need to compute my cost basis manually?
As a service to our shareholders, Lord Abbett will provide an average cost basis statement (to the extent available) which reflects the gain or loss on sales of fund shares using the average cost basis method of disposing shares purchased prior to January 1, 2012. The average cost basis statement is not sent to the IRS and you are not required to use it. Beginning with shares purchased after January 1, 2012, Lord Abbett is required to compute and report the basis of shares sold to you and the IRS. For additional information on Mandatory Cost Basis Reporting, please visit our <U>cost basis resource center.
What is a "wash sale"?
If you sold a fund at a loss and repurchased the same fund within the period 30 days before and 30 days after the trade date (the 61-day window); such a loss may be disallowed to the extent of the repurchased positions. It also should be noted that dividends reinvested are considered purchases and, therefore, may potentially cause a wash sale if reinvested within the 61 day window of the sale at a loss.
What information do I need in order to compute my original basis and holding period?
In order to compute your adjusted cost basis, you must first determine your original cost. The information needed in order to determine the original cost basis and holding period of shares that were purchased and not inherited or gifted is:
• Trade date of each purchase, including dividend reinvestments;
• The number of shares purchased;
• Cost of the shares purchased; and
• Any sales charge or commission paid for each purchase.
How do I determine which shares are sold?
If you held a fund for numerous years, participated in an automatic investment plan or elected to reinvest dividends, you will hold many small lots of shares purchased at different points in time at different prices. These lots will have different adjusted cost basis and holding periods. In order to determine which shares are sold, you may use specific identification, first in first out (FIFO), or an average cost method. If either of the first two methods are used, you need to track each lot's adjusted basis and holding period separately in order to determine the gain or loss on disposition. If an average cost method is used, you would still need adjusted cost and holding period information, but the gain or loss is determined based upon the average cost of the shares. Average cost methods may be used only for mutual fund investments.
(See IRS Publication 550 for detailed instructions on how to compute gains or losses.)
Sale of Mutual Funds
Prior to cost-basis reporting, how did reporting on sales of mutual fund shares work?
When you sell a mutual fund, you generally realize a capital gain or loss. The gain or loss is computed by subtracting the adjusted cost basis from the proceeds of the sale. The adjusted cost basis typically is the amount you paid to purchase fund shares adjusted by certain items, such as a tax return of capital or wash sale. If the proceeds exceed the adjusted cost basis, you recognize a gain. If the adjusted cost basis is more than the proceeds, you will recognize a loss on the sale. Different rules apply to tax-exempt accounts and tax-exempt investors.
Your historical records (e.g., periodic account statements, transaction confirmations, prior year’s 1099s) will be the source of determining the adjusted cost basis and purchase dates. Proceeds from the sale will be reported to you on Form 1099-B by your broker or mutual fund family.
Based on a combination of all this information, you must then compute the gain or loss on the sale and determine the holding period of the shares—long or short term. The holding period will dictate the maximum tax rate applicable to the resulting gain or loss.
As a service to their clients, most mutual fund families, including Lord Abbett, provide shareholders with an average cost-basis statement in conjunction with Form 1099-B. This statement reflects the gain or loss and the holding period for each sale that occurred during the year by using the “single category average cost basis method” approved by the IRS.
The average cost-basis statement is not filed with the IRS, and you do not have an obligation to use it.
How will reporting of mutual fund sales work going forward?
When you sell a security that was purchased after the effective date (January 1, 2011, for stocks, and January 1, 2012, for mutual fund shares), you must select a cost-basis method or instruct the broker or mutual fund family as to which lot of shares to sell by specifically identifying lots. A lot is created each time you purchase additional shares. Dividends reinvested also create a new lot. Lots purchased at different times and prices have a different holding period and cost basis.
The cost-basis method you use for shares acquired after the effective date can be different from the method used for shares acquired before the effective date.
By February 15 of the year following the applicable effective date (January 1, 2011, or January 1, 2012), the broker or mutual fund family will send you a Form 1099-B that will indicate the proceeds, adjusted cost basis, holding period, and other information for each sale.
You are required to use this information when preparing your income tax return; it also will be reported directly to the IRS.
Can shareholders specifically identify shares to sell?
Yes. Regardless of the cost-basis method on your account, you can specifically identify shares you would like to sell by calling the Lord Abbett Service Center. It is important to note that if you specifically identify shares to sell, you will no longer be provided with an average-cost-basis information on noncovered shares for this fund. Therefore, before you sell specific shares, please ensure that you have all the information necessary to compute the cost basis on noncovered shares manually, as we can no longer provide you with this information.
When should a shareholder specifically identify shares to sell?
In addition to the fund’s default method of average cost, you may choose FIFO (first-in, first-out), LIFO (last-in, first-out), LOFO (lowest-in, first-out), HIFO (highest-in, first-out), and LGUT (loss/gain utilization) as your method of selecting shares. We believe that most tax lot–selection strategies can be accomplished by using one of these methods. In the rare case your lot-selection strategy cannot be accomplished by using one of these methods, you may specifically identify shares to sell by calling the Lord Abbett Service Center. Please note that if you specifically identify shares to redeem, we will no longer be able to provide you with average-cost-basis information on noncovered shares.
Cost Basis Reporting: Impact on Shareholders
What is mandatory cost-basis reporting?
Mandatory cost-basis reporting shifts to the broker or mutual fund family the burden of computing the holding period of a security, the adjusted cost basis, and resulting gain or loss based on an investor’s selected tax lot relief methodology. As a result, the reporting entity is now responsible for both computing the information and reporting it to the investor and the IRS.
Why did congress pass mandatory cost-basis reporting?
Congress believes that some taxpayers who sell securities are overstating their cost basis (i.e., the amount paid for a security) and, therefore, understating gains on the sale of securities. This understatement results in the underreporting of taxable income and related taxes, and, thus, lower tax revenue for the government.
To ensure greater compliance with existing tax laws and to minimize potential lost tax revenue, Congress passed mandatory costs-basis reporting as part of the Emergency Economic Stabilization Act of 2008.
Choosing or changing a cost-basis method
What is the difference between revoking and changing an average-cost-basis method?
You will be able to revoke the average-cost-basis method no later then your first redemption date. By revoking the average-cost-basis method, the tax basis of each share will revert back to its original basis. All such shares will no longer maintain the same average cost basis per share. After a redemption has occurred using average cost, you may only change to another method going forward (as described above) and can no longer revoke the average-cost-basis method. This means that all shares acquired prior to the change will maintain the same average cost basis per share. Any shares acquired after the change will keep its original cost basis and will not be averaged with prechange shares.
What method will be used on a new account that a shareholder opens?
Generally, when you transfer to a new fund, your personal information, including the cost-basis method, is copied form the "old fund" to the "new fund." To the extent the old fund does not have a cost-basis method assigned, the fund's default of average cost will be assigned to the new fund. You may change the method at any time.
Can a shareholder change the method used on a transaction at a later point in time?
No. In accordance with IRS regulations, once a transaction has settled, you cannot change the method used for that transaction. Because of this, it is important to consider the cost-basis method used at the time of the transaction.
How frequently can a shareholder change their method?
You may change your method as frequently as you like. You are not required to use the same method for every redemption transaction. However, if you have chosen to use average cost or were defaulted to average cost, you may only change to another method either in writing or on our Website. Changes to or from a method that does not include average cost may also be made by telephone.
Can a shareholder elect a method to be used on shares purchased prior to Jan. 1, 2012 ("noncovered shares")
Lord Abbett does not intend to change the approach on reporting noncovered shares. Lord Abbett will continue to supply average cost-basis information on noncovered shares to eligible account holders. Lord Abbett will not supply shareholders with cost-basis information using a method other than average cost on noncovered shares. A shareholder is not required to use the average cost-basis information on noncovered shares, and it will not be reported to the IRS.
When can a shareholder choose a method?
You may choose a method at any point; however, if a method is not chosen by January 1, 2012, the default of average cost will be used. You will be able to revoke the default average-cost method and choose a different method provided you do so before the first redemption date following January 1, 2012. Once you redeem or exchange shares using the average-cost method you can no longer revoke the average cost-basis method; however, you may change to a different method going forward for shares purchased after you make a different election.
Which method is best, and how can a shareholder make an election?
Each shareholder's tax situation may be different; therefore, the "best" method for one shareholder may not be the best for another. A shareholder may want to discuss his personal tax situation with his advisor prior to selecting a method.
If you would like to use a method other than the default average cost method, you may do so online by visiting www.lordabbett.com, by contacting us at 800-821-5129, or by completing a Cost-Basis Method Form
Emergency Economic Stabilization Act of 2008
When does the new act go into effect?
The Act is being implemented in three phases. The first phase relates to equity shares (stocks) purchased on or after January 1, 2011; the second phase affects mutual fund shares purchased on or after January 1, 2012; and other securities are covered on or after January 1, 2013.
Does the act affect a shareholder if he or she hasn’t sold a security?
Anyone who owns a security will be required to inform the broker or mutual fund family through which they hold the securities to be sold as to which tax lots they want to sell no later than the first sale of such securities.
Alternatively, an investor may inform a broker or mutual fund family of their preferred tax lot relief methodology and have that method apply to all future sale transactions. Otherwise investors do not need to take any further action unless they sell a security and are preparing a tax return. Investors will receive from their broker or mutual fund family the computed net proceeds from the sale of the security, the holding period for the security, the adjusted cost basis, and the resulting gain or loss on Form 1099-B and must include that information on their tax return.
What information is needed to compute gains or losses?
The Act does not change how to compute gains or losses; it only changes who (i.e., brokers and mutual fund families—not investors) computes and reports holding period information for the security, adjusted costs basis, and the resulting gain or loss to the IRS. Brokers and mutual fund families also will provide that information to the investor.
What is changing as a result of the stabilization act?
Specific changes resulting from the new mandatory cost-basis reporting law will include:
Brokers and mutual fund families are required to select a default cost-basis method.
Investors will need to identify the specific lots to sell upon redemption, select a cost-basis method that they want to use for their account, or do nothing and use the default method.
Based on the investor’s selection, brokers and mutual fund families will compute and report net proceeds from the sale of a security, the holding period information for the security, and the adjusted cost basis (the amount you paid to purchase fund shares adjusted by certain items, such as a tax return of capital or wash sale), to both the investor and the IRS.
Cost Basis Options
Does a shareholder have to choose a method?
No. All Lord Abbett funds will use the average cost-basis method to compute and report cost basis on sales of shares purchased after January 1, 2012, unless the shareholder (or their broker) provides instructions to use a different method. If the shareholder would like to use the default method of average cost, no action is required. If your preference is to use a method other than average cost, then you must inform us of your preferred cost-basis method.
Why would a fund choose average cost as its default method?
As a service to our shareholders, Lord Abbett has been supplying cost-basis information on shares purchased prior to January 1, 2012, to eligible accounts using the average cost-basis method. In order to maintain consistency, Lord Abbett has chosen average cost as the default method for shares purchased after January 1, 2012.
What is a fund’s default cost-basis method?
A fund's default cost-basis method is average cost.
Which cost-basis methods can a shareholder choose?
Lord Abbett will support six different cost-basis methods. In addition, a shareholder will have the ability to specifically select the shares that she/he wishes to sell instead of using one of the cost-basis methods. Below is a list of all the available methods and a description for each. Numerical examples of each method can be found in Cost-Basis Method Examples
Average cost (ACST)—Assigns the average cost to all shares in an account by averaging the cost basis of all acquisitions (including dividend reinvestments) made after January 1, 2012, in the account. Similar to the first-in, first-out method, the oldest shares will be sold first. Once a share has been averaged, its new average cost will replace the original cost basis.
First-in, first-out (FIFO)—Shares acquired first (including dividend reinvestments) after January 1, 2012, in the account are the first shares sold.
Last-in, first-out (LIFO)—Shares acquired last (including dividend reinvestments) after January 1, 2012, in the account are the first shares sold.
High cost (HIFO)—Shares with the highest cost per share (including dividend reinvestments) acquired after January 1, 2012, are the first shares sold. This method will minimize the overall gain and maximize the overall loss.
Low cost (LOFO)—Shares with the lowest cost per share (including dividend reinvestments) acquired after January 1, 2012, are the first shares sold. This method will maximize the overall gain and minimize the overall loss.
Hybrid cost-per-share and acquisition-date-ordering method
Loss/gain utilization (LGUT)-Depletes shares acquired after January 1, 2012, with losses (first short-term shares in HIFO order then long-term shares in HIFO order) before gains (first long-term shares in HIFO order then short-term shares in HIFO order) consistent with the objective of maximizing losses and minimizing gains with attention to holding period. This method recognizes that the historical maximum tax rate applicable to long-term gains is less than short-term gains. Unlike HIFO, this method may not produce the largest overall loss or smallest overall gain; however, in certain limited circumstances, this method may be more tax efficient because the holding period (long or short term) is considered.
Read Cost-Basis Method Examples to understand how each method impacts the resulting gain or loss.
Cost Basis: The Basics
What is a tax lot?
A tax lot is created whenever additional shares of a fund are purchased. Dividends reinvested are also considered purchases and, therefore, create a new tax lot. For example, if you purchased a mutual fund and elected to reinvest monthly dividends, you will have 25 tax lots after two years (the original purchase plus 24 dividend reinvestments). Each of these tax lots were purchased on different dates and at prices that may also be different.
How does the cost-basis method impact a shareholder’s tax liability?
As described in the previous question, tax lots will have different purchase dates and prices. The order in which these lots are to be sold is based upon the cost-basis method used. Different methods may produce a different order of shares to be sold. Because lots have different purchase prices and dates the gain or loss and associated holding period (long or short term) may be different depending on the cost-basis method used.
Why is the holding period important?
The maximum federal income tax rate on securities sold that were held longer than one year (long-term gain) generally is lower than the maximum federal income tax rate on securities held for one year or less (short-term gain). For example, if a shareholder purchased 100 shares at $10.00 per share on January 31, 2012, and another 100 shares for the same price, $10.00 per share, on June 31, 2012, both tax lots have the same cost basis ($10.00 per share), but different purchase dates. If this shareholder sells 100 shares on March 15, 2013, for $12.00 per share, his tax liability will vary depending on the lot that was sold. Assuming the January 31, 2012, lot was sold, the resulting long-term gain would be $200.00 (100 shares multiplied by the difference is the sale price of $12.00 per share and the cost basis of $10.00 per share). Assuming a long-term capital gain rate of 15%, the shareholder's liability is $30 if the first lot is sold. If instead the second lot is sold, the gain will still be $200, because both lots were purchased at the same price; however, the gain will be considered short term. Assuming a short-term capital gain tax rate of 35%, the shareholder's tax liability will be $70. In this scenario, choosing the first lot would produce a smaller tax liability.
What is a cost-basis method?
A cost-basis method is a systematic approach for ordering shares to be sold that were purchased at different times and at different prices. The order of the shares is used to determine which shares are sold first.
Why is the purchase price important?
The cost basis of a tax lot is determined by its purchase price adjusted by various tax items, including wash sales and returns of capital. To the extent a shareholder holds multiple lots with a different cost basis, each lot will produce a different gain or loss.
Redemptions in a cost-basis World
Will reporting to the IRS Change?
No. You have always been, and continue to be, responsible for reporting cost basis to the IRS. What's changed is that we are now required to report cost basis to you and the IRS on covered shares. The reporting on noncovered shares has not changed.
Which cost-basis adjustments is a shareholder required to make?
We will only adjust the basis of shares held in an account due to activity that occurs within the same account (covered and noncovered shares are considered separate accounts). A shareholder is required to consider all potential adjustments, including across accounts, when reporting to the IRS. Some examples of potential adjustments you may need to make are listed below:
Wash sales—If you sell a fund at a loss and repurchase the same fund within 30 days before or after the sale date (61-day window), all or a portion of the loss may be disallowed due to the wash sale rules. The cost basis and holding period of the shares that were purchased, and thus triggered the wash sale, need to be adjusted. To the extent that this wash sale occurred due to covered shares sold and bought back within the same account, we will adjust and track the new basis. However, if the transaction occurred across two accounts (i.e., sale in one account and purchase in a separate account), then we cannot adjust the basis.
Load-basis deferral—If you purchase shares with a sales charge and then transfer to another fund without paying a sales charge (due to reinvestment privileges) before the 91st day after purchase, any gain or loss generated by the transfer should be adjusted by the sales charge waived. The basis of the new fund should also be adjusted by the waived sales charge.
Six-month loss—If you sell a fund at a loss after holding it for six months or less and received a long-term capital gain distribution, the short-term capital losses generated by the sale should be treated as long-term losses to the extent of long-term capital gain dividends received.
Which shares are sold first in a bifurcated account?
Noncovered shares will always be redeemed before covered shares. The cost-basis method on your account will only be used on covered shares after all noncovered shares are completely sold.
What if the shareholder doesn’t agree with the information on covered shares reported to them and the IRS on Form 1099-B?
It is ultimately the shareholder's responsibility to report the correct cost basis to the IRS. The new IRS Form 8949 provides you with an opportunity to adjust the cost basis reported on Form 1099-B. In addition to the numerical adjustment, you must also provide a reason for the adjustment based upon the standard reasons supplied by the IRS. For more information, please refer to the instructions for Schedule D.
What year-end tax reporting will a shareholder receive if he or she owns both covered and noncovered shares?
Shareholders who own covered (shares purchased after January 1, 2012) and noncovered shares (generally shares purchased prior to January 1, 2012) of a fund will be considered as owning a bifurcated (split) account. This means that for tax reporting purposes only, the shareholder’s investment in the fund will be split and grouped into covered and noncovered shares. Each group of shares will be treated as a separate account (for tax reporting purposes only), and the tax reporting will differ as described below:
Noncovered shares—We are required to report only the proceeds of a redemption to the IRS and shareholders on Form 1099-B. In addition, as a service to our shareholders, we will continue to provide them (but not the IRS) with average cost basis information in order to assist shareholders with reporting the cost basis on noncovered shares to the IRS. Shareholders are not required to use this information.
Covered shares—We are required to report the cost basis to you and the IRS on Form 1099-B. The cost basis will be computed based upon the fund’s default method of average cost, or another method of your choosing. You are required to use this information to report cost basis to the IRS.
If a shareholder owns an account that has both covered and noncovered shares, and intends to continue using the average cost-method, what will change?
As described above, there will be no change in the information we report to the IRS on noncovered shares. However, the cost basis information will now be reported on Form 1099-B instead of the average- cost-basis statement. In addition, because the fund will be considered bifurcated (contains both covered and noncovered shares), we will compute two, average-cost-basis per share amounts—one for covered shares and the other for noncovered shares.
Can a shareholder use a method other than average cost on noncovered shares?
Yes. However, we can only provide cost-basis information on noncovered shares using the average-cost method. You are not required to use the cost-basis information provided on non-covered shares and may compute your cost basis using any other IRS-approved method. Please note that if you intend to compute the cost basis manually, you should maintain detailed records of all transactions in addition to your calculation. Also, if you redeemed/exchanged out of a fund in the past using the average-cost-basis method, you may be restricted by the IRS in changing to another method.
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A little advance planning may save you money and headaches when tax time comes.
March 27, 2014
Vito Fronda and Brian Dobbis discuss some of the tax law changes investors need to know.
The information presented in this section is intended for general information and is not intended to be relied upon and should not be relied upon, as financial, legal or tax advice for any particular investor. We strongly recommend that you contact your financial, legal or tax advisor regarding your particular tax situation.
The information presented in this section is not written or intended to be used, and cannot be used, for the purpose of avoiding any tax liabilities or penalties.