When mutual funds distribute their income to shareholders, the distributions may fall into one of several categories. Each is governed by a different set of tax rules.
Net gains from the sale of securities held by a mutual fund for more than one year and then distributed to shareholders are subject to long-term capital gains tax rates, which are currently lower than ordinary income tax rates.
Your federal long-term capital gains tax rate may depend on your ordinary income tax rate including capital gains realized, as you can see in the table below. It’s important to note from 2008 to 2010 tax rates on long-term capital gains will be eliminated altogether for taxpayers in the 10% and 15% ordinary tax brackets2. In 2011, unless Congress changes current tax laws, rates on capital gains for investors in all tax brackets are scheduled to revert to rates that were in effect prior to 2003.While the 0% rate on realized, long-term capital gains can benefit some taxpayers; those gains would increase adjusted gross income which affects other tax items, for example, potentially subjecting social security benefits to tax, reducing the medical expense deduction and limiting the retirement saver's credit. Furthermore, realized gains may push taxpayers into a higher income tax bracket, subjecting those gains to tax at a 15% rate.
| Income
Tax Rate |
Rates
on Long-Term Capital Gain 2006-2007 |
Rates from 2008-2010 |
| 10% | 5% | 0% |
| 15% | 5% | 0% |
| 25% | 15% | 15% |
| 28% | 15% | 15% |
| 33% | 15% | 15% |
| 35% | 15% | 15% |
1. Information does not apply to Section 1250 gain.
2. Unless Congress acts before then.
Unrecaptured Section 1250 gains are long-term capital gains from certain depreciation on real estate. Mutual funds, such as RiverSource® Real Estate Fund, may designate a portion or all of a capital gain dividend as Unrecaptured Section 1250 gains, which may be taxed at a rate of 25%.