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<<Thanks ...I think I am finally starting to understand all this ...another point...if I have the dividends
paid to me directly, I will still eventually have to pay ordinary dividend interest on this money at tax
time, correct? So either way does it really matter which way I do it?

Also....Besides the obvious reasons why people buy mutual funds(having other people handle your
money) why would someone want to pay cap gains taxes every year thru the fund and then again
when we sell the shares of the fund? Aren't we actually being taxed twice on the same money or am
i missing something?............thanks for your time...Debbie>>

Distributions from the fund (whether or not they are reinvested) are always taxable (unless this fund is in a tax-deferred plan such as an IRA). If the funds are paid directly to you, that's the end of the story. You get the cash; you pay the tax on it.

If you reinvest the distributions (dividends, capital gains, whatever) you STILL pay tax for the year they were received, but your cost basis in the fund becomes the reinvestment price for the shares. So, when you tax out, your only paying tax on the gain in these new shares. Perhaps an example would help:

500 shares of XYZ @ $30/share (bought at $10.00)

Fund distributes earnings:
$ 20.00 in divs
$100.00 in ST Gains (held 12 months or less)
$ 50.00 in 28% gains (held between 12-18 months)
$200.00 in LT gains (held longer than 18 months)
Reinvest Price: $28.00 (the price will drop because money formerly held in the fund is being released)

You'll pay tax on the $370 in 1997 (at a variety of rates due to the types of distribtution. That's best left to another post...).

Let's say you reinvest the money. You'll now have an additional ($370/$28)= 13.21 shares. On 3/31/98 you decide to sell all of your holdings. Your taxable gain would be calculated as follows:

513.21 shares sold at $32.00/sh

Gain on 500 shares = 500 x ($32-$10) = $11,000 (L/T rate)
Gain on 13.21 shares = 13.21 x ($32-$28) = $52.84 (S/T rate, because the shares were only purchased 3 months ago). As you can see, you're not being double-taxed; you're only paying on the gain since the reinvestment date. Hope this helps.
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