What are the tax consequences of a capital gain distribution? 

Let’s talk about it.

Many people have been wondering how the US government taxes capital gains.  This article describes what capital gains (and possibly capital losses) are, and how taxes are distributed on them.

What is a Capital Gains Distribution?

This refers to proceeds’ payment prompted by liquidation of underlying securities and stocks by fund managers.  This occurs when the manager of mutual fund liquidates positions that have generated gains since their addition to the fund, i.e when he/she (manager) sells a security that is in the portfolio which has gained value.  Capital gains are also realized when one sells a capital asset like stock and gains profit. Capital gains can be short-term or long-term.  Let us consider the following questions before proceeding.

What is the difference between long-term and short-term capital gains?

Long-term capital gain is the gain on any investment which has been kept for at least one year.  On the other hand, short-term capital gain is the gain on any investment which has been kept for utmost one year.

How are dividends taxed?

Long-term capital gains usually carry a maximum dividend tax rate of 20% while short-term capital gains usually carry up to 39.6% dividend tax rate.  Note that this taxation rate vary from one country to another.

What is the purpose of mutual funds distributing capital gains?

The law requires the income generated to be paid to the mutual fund’s shareholders in form of distributions as qualified dividends.

What are qualified dividends?

These are ordinary dividends that strictly meet the taxation criteria for long-term capital gains at the lower level rather than individual’s higher tax rates for ordinary income.

In United States for example, taxation for short-term capital gains and ordinary dividends is as follows: Tax rate is the same as that of ordinary income.  Alternatively, taxation for long-term capital gains and qualified dividends is as follows:  No tax for 10 percent to 15 percent brackets, but for 25 percent to 35 percent brackets, the tax rate is 10 percent and 20 percent for 39.6 percent bracket.  After calculating the taxable loss or gain as a result of selling an asset, the cost basis (for the asset) is deducted from the final amount on its sale.  Note that cost basis is the asset’s purchase price after certain factors like brokerage fees and depreciation have been adjusted.

In general, for securities held for one year or more by the fund, tax rate for the capital gain is lower than for securities held for one year or less, which are taxed in the same way as ordinary income.  Now the big question is, “Is there capital gains when the net value of the asset has fallen?” To answer this, you should be able to affirm that though a fund’s share may fall, there is a possibility of the fund realizing capital gains for example on stocks that went up significantly during the year.  Therefore, capital gains and losses are possible in this scenario.

In conclusion, your capital gains are treated as your revenue by the government, so they should will be taxed based on the taxation policy of that country.  The rates are not constant but are subject to change depending on the respective country’s economic situation.