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Here is an overview of the commonly asked tax questions relating to investing in a mutual fund.
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.
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.
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.
- 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.
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.
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.
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.
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.
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.
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.
A fund's default cost-basis method is average cost.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.