Dear Clients and Friends:

Below are several tax surprises that your mutual fund investments may cause:

First, you may not be aware of at least a couple of unexpected ways in which you may make taxable 'sales' a part of your interest in a mutual fund. In fact, you may already have made taxable sales a part of your mutual fund investment without knowing it.

One way this could happen is if your mutual fund allows you to write checks against your investment in the fund. The IRS says that every time you write a check against your mutual fund account, you have made a partial sale of your interest in the fund. Except for money market funds where the share value is constant, you may therefore have taxable gain (or a deductible loss) whenever you write a check.

Here's another way you can get hit unexpectedly with taxable sale treatment. Say that your mutual fund organization allows you to make changes in the way your money is invested, for instance. You can switch part of your investment from a stock fund to a bond fund, and making such a switch is treated as a taxable sale of your shares in the stock fund.

Record-keeping is important. Be very careful about saving all the statements that the fund sends you--not only official tax statements, such as Forms 1099-DIV (or the fund's version of the 1099-DIV), but the confirmations that the fund sends you when you buy or sell shares, or when your dividends are reinvested in new shares in the fund. Unless you keep these records, you won't be able to prove how much you paid for the shares, and thus the amount of gain you have to pay taxes on (or the amount of the loss you can deduct) when you sell them. You will also need to keep these records to prove how long you've held your shares, e.g., more than 12 months if you want to take advantage of the 20% rate ceiling on such gains. (If you get a year-end statement that lists all your transactions for the year, then you can just keep that and discard quarterly or other interim statements or confirmations. But save anything that specifically says it contains tax information.)

Time your purchases and sales. If you're planning to invest in a mutual fund, there are some important tax consequences that you should take into account in timing the investment. For instance, an investment shortly before the payment of a dividend is something you should generally try to avoid, since you may, in effect, be buying a tax liability. If you're planning to sell (redeem) any of your mutual fund shares, timing is also important. A properly timed sale can save you tax dollars.

Identify the shares you sell. If you're planning to sell some but not all of your shares, there are complicated rules you should first consider about how to identify the shares you're going to sell. The proper application of these rules can reduce the amount of gain you will have to pay taxes on, or qualify the gain for favorable long-term capital gain treatment.

If you would like to find out more about tax planning for buying and selling mutual fund shares, please give me a call at (315) 363-3338.

Very truly yours,

G. William Hatfield
Certified Public Accountant
Certified Financial Planner