I'm embarassed to ask such a seemingly simplistic tax question, but here goes. I am new to investing and have only one mutual fund account with Seligman. After my intial investment, I have $50 per month invested directly into the account. I have never taken any withdrawls out of the fund only these small incremental additions. Well on November 30, something strange happened - for no apparent market reason the listed value of the fund shares dropped from ~ $32 to ~$24 and the newspaper mentioned that "Both 12b-1 and redemption charge in effect". What the heck is going on? But the real tax question is this - What sort of capital gains charges do I have to pay if I didn't sell any shares of the fund? Seligman sent me a form with a dollar figure broken down into two sums, designated as (I don't have the form in front of me) "short term ..." and "long term ... " How do these relate to the schedule D form (1090?) that I have to fill out? I'm obviously confused - I thought that you didn't pay capital gains taxes until you "cashed out"? Help! Any advice would be very appreciated.

<<Well on November 30, something strange happened - for no apparent market reason the listed value of the fund shares dropped from ~ $32 to ~$24 and the newspaper mentioned that "Both 12b-1 and redemption charge in effect". What the heck is going on?>>

The fund managers have been indicted for fraud and theft. Weren't you following that news story? If your heart is still beating, this is my sense of humor showing itself. Actually, what probably happened was that the fund made a distribution. This is common at year-end. If you look at your fund statement, you should see additional shares of the fund given to you in exchange for the lower price per share. DrBear recently posted a reply with detailed math, so I won't go into it again. I'll just leave the link for you to follow. That specific question concerned being taxed twice which you also ask about.

http://boards.fool.com/Message.asp?id=1040014001198003

<<But the real tax question is this - What sort of capital gains charges do I have to pay if I didn't
sell any shares of the fund?>>

See the distribution question again and DrBear's math. Even if you don't sell shares, the fund still buys and sells stock. This creates the capital gains. Since the fund doesn't pay tax, the taxable event is passed on to the shareholders. Here's a hint to help you look like a pro when talking about mutual funds. Look at the fund's turnover rate. The higher the rate, the more stock it is selling each year and the more tax you'll have to pay even if you don't sell shares. A tax-managed fund refers to one that minimizes turnover within the fund (a buy-and-hold strategy) so your taxes will be minimized if the money you invest is not in an IRA.

<<...a dollar figure broken down into two sums... short term ..." and "long term ... " How do these relate to the schedule D form (1090?)>>

Now for the real fun. Place all of Box 1a (1099) on Line 5 of Schedule B. Place the total of Box 1c on Line 7 of Sch.B and also on Line 13, column (f) of Sch.D. On Sch.B, when you subtract Line 7 from Line 6 (same as Line 5 since you only have one fund to list), the remainder should be the same as Box 1b. If not, then you misread the numbers from Box 1c. Make sure that you are getting the correct total from Box 1c. Most funds list one total with a sub-amount listed as the 28% gain (I'll cover that later). If your 1099 lists long and short, then these added together would be the total. Go back to Sch.D. On the 1099, as I just said, Box 1c should have a sub-amount listed as "28% gains" or short-term gain or something to that effect. Place that amount on Line 13, column(g) of Sch.D. The rationale is that the total gain (column f) is made up of the short-term gain taxed at 28% (column g) and the long-term gain taxed at the new, more favorable rate(s) of 20%/10%. However, the long-term gain by itself is not broken out on the front of Sch.D. Now finishing Sch.D is simply a matter of following the directions. Do it slowly, double check your answers and then have a fresh set of eyes recheck again.

<<I'm obviously confused - I thought that you didn't pay capital gains taxes until you "cashed out"?>>

By now, you already know the answer to this. If the money was in an IRA, then you would be correct.

On 4/10 I responded to your question. What a difference a night's sleep makes. After my lengthy first answer I began to have some concerns about confusing rather than helping you.

The information specifically relating to 1040 Schedule B, 1040 Schedule D and the 1099 Boxes 1a, 1b, and 1c is correct, but when I reread your original question I wanted to add some more commentary. You said:

<<Seligman sent me a form with a dollar figure broken down into two sums, designated as (I don't have the form in front of me) "short term ..." and "long term ... " How do these relate to the schedule D form (1090?)>>

First, please check to make sure that the form *is* a Form 1099. This is the report that will be given to the IRS so it is this specific form that the tax numbers must be taken from. Do not use an account statement or summary. The form should clearly be labeled as 1099 or 1099-DIV.

Next, you mention the breakdown of short-term and long-term dollars. The 1099 will have the separate boxes that I listed. My concern is that you said only two numbers were shown. Typically, all three boxes will have numbers, with Box 1c being subdivided to show the 28% gain. This 28% gain is not really a short-term gain so I don't want to cause confusion.

Box 1a is the gross amount. Box 1b is dividends, whcih is where Sch.B comes into play. Box 1c is capital gains, which includes the amounts taxed at both the new (10%/20%) and old (28%) maximum tax rates.

Since you said you weren't really sure what was on the form because it was not in front of you at the time, this may all be very clear once you look at the form again. If not, let us know what information the form does contain.

I have a further comment on tc001's clarification. I had an extended discussion here a while back with someone who said they had a report indicating that a certain amount of their mutual fund dividend was made up of short-term gain. I was surprised to hear this because there would appear to be no tax reason for them to report this. (Maybe the securities laws require dissemination of this information?) But the person providing this information seemed to be quite clear that this was the case, and that we were not talking about 28% gain (which tc001 correctly identified in his second message as a category of long-term gain). The point is that short-term gain does *not* retain its character when it is distributed by a mutual fund to its shareholders. It is taxed as ordinary dividend income -- a point that brought woe to the person who asked the earlier question because that meant it could not be offset by a large capital loss in the same year.

KAT in Chicagoland
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