When a shareholder receives distributions, that shareholder is subject to tax implications. Almost everyone who invests is subject to taxes, especially when they receive an income from their investments. The only way in which tax is not paid on the income is when it stays in the account rather than the shareholder's pocket.
But even if you don't sell your shares, you still may have to pay taxes. Your investments may gain dividends or other types of distributions that are paid to you buy the investment management company. Any time you receive a distribution, which includes dividends, you must pay taxes on that distribution.
The reason why you have to pay taxes is because the distribution of dividends or any other distribution from the mutual fund is considered income. It doesn't matter how small or large, the income must be reported on your income tax return.
Some wonder why the investment company does not simply reinvest the dividends. Reinvesting them would mean that the shareholder wouldn't have to pay the taxes since they never received it as income. However, the investment company is allowed to make the decision to reinvest or distribute.
In some cases, especially when annual dividends are paid, a person may be able to avoid tax implications. The distributions on mutual funds are usually carried out later in the year. It is because of this that some investment managers will advise their investors to not buy into mutual fund fees before this distribution. This is because a portion of the investment will come right back to the investor and make their end of the year distribution bigger.
When an investment is quickly turned around like that, the tax implications equal to a loss. Basically, an individual has increased their tax bill with a fund purchase that has not had any time to gain enough for it to truly be deemed a profit. This isn't like when a fund purchase is done in January and it has gained all through the year.
Although buying before distribution is generally not a good idea, it does depend on whether or not there is a chance that the fund may increase significantly. The idea would be for the value to go up more than the taxable amount would cost. This is how a profit could be made with such a move. The unfortunate fact, however, is that, although a prediction would state that such a gain would be possible, such a gain may not happen at all.
Nevertheless, you should look at the situation objectively so that you can make the right decision regarding investing. Just because you want to avoid a capital gains tax isn't a good reason to avoid investing at the end of the year. If you look at a situation and you feel wholeheartedly that the benefit you will experience is greater than any tax that may be imposed on you, then you should go for it.
The idea is for you to not worry about beating the tax man, but thinking about how it is you can make money from your investments. You can consult with your certified financial advisor and see which is best for you. That way, your next move can be an effective move that benefits you rather than hurts you.
And remember that any losses you experience can be claimed on your tax return so that you can receive a tax benefit. Even though you may experience a loss on your investment doesn't mean that you are going to have to take the entire loss. By understanding distributions and tax implications they represent, you can offset some of it.
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