Vanguard Mid Cap Index Fund tax distributions

The Vanguard Mid Cap Index Fund is a suitable candidate for placement in taxable accounts. The table below summarizes the fund's relation to a number of tax factors.

The following tables provide long term data on the fund's history of both dividend and capital gains distributions. The first table also provides the historical distribution of qualified dividends.

The second table provides a database of the fund's accounting figures: the annual level of realized and distributed gains; its level of unrealized gains and loss carryforwards; as well as the annual in-kind redemption gains the fund has realized. These figures highlight the level of a fund's tax liabilities.

Because both manager turnover of securities inside the portfolio and investor turnover of fund shares can affect the level of gains realization, a third table provides historical turnover ratios.

Distributions
The following table provides a view of the fund's historical distributions expressed in terms of yields. We can see that the fund distributed substantial levels of capital gains during the early years of its existence, a period which coincided with a long bull market. The fund has not distributed a gain since 2002, a period marked by two bear markets and by the presence of an ETF class in the fund. The fund has distributed 89%  qualified dividends, which under the current tax regime, are taxed at lower capital gains tax rates.

The fund has changed tracking indexes twice in its history. The transition years of benchmark changes are marked in red shading.


 * FY 2014 - The fund changed benchmarks from the MSCI 450 Mid Cap Index to the CRSP US Mid Cap Index on 01/31/2013.
 * FY 2004 - The fund added an ETF share class on 1/26/2004.
 * FY 2004 - ETF shares dividend annualized in 2004.
 * FY 2003 - The fund changed index benchmarks from the S&P 400 Index to the MSCI 450 Mid Cap Index on 5/16/2003.
 * FY 2001 - Admiral shares dividend annualized in 2001.
 * FY 1998 - Investor shares dividend annualized in 1998.

Accounting data
Reference article: Average net assets

The accounting figures and associated ratios (tables 3 and 4) can help one visualize some of the major determinants of a fund’s tendency to distribute taxable gains. These determining features include:

Turnover: The rate at which a fund manager sells securities within the fund has a major effect on potential gains realization. Single digit annual fund turnover percentages result in a low rate of realized gains. Similarly, fund shareholders' sales flows have major effects on a fund’s distribution tendencies. Net flows into the fund have the following effects:


 * 1) Constant inflows allow a fund manager to purchase a wide range of price lots for shares. The manager can select high basis shares when forced to sell a stock (this may realize a loss). The manager can also select low basis shares when redeeming a stock in-kind (a non-taxable transaction that can remove an unrealized gain out of the portfolio.)
 * 2) A large and growing net asset base serves to diffuse any realized capital gains across a large base of shareholders and reduces the per share gain distribution. Large outflows have the opposite effect; any gains realized are spread across a smaller asset base and result in higher per share distributed gains.

The level of unrealized gains and carryover realized losses in a fund: A fund which defers gains realization accumulates unrealized appreciation, which when distributed, will be taxed; thus the unrealized gain/loss figure shows the potential gain (or loss) that would be realized if the portfolio was to be entirely liquidated. Any loss carryovers a fund possesses can be used to offset future realized gains (carryovers have an eight year expiration period). The third tab on the Table 3. spreadsheet shows the data in percentage of total assets form.

Turnover
Reference article: Average net assets


 * Shareholder turnover in 2010 is magnified by investor share to admiral share conversion due to the liberalization of the Admiral share program (minimum investment lowered to $10,000).
 * Shareholder turnover in 2007 is magnified by admiral share to signal share conversion due to policy change in Vanguard employer provided plans (the use of signal shares).
 * Shareholder turnover in 2000 is magnified by investor share to admiral share conversion due to creation of admiral shares.

Tax rates
Mutual fund distributions will be taxed according to the tax laws governing the investment over the holding period of the investment, which are subject to change. The actual tax imposed will depend upon each individual's tax rate and the timing of purchases and sales. The federal tax rates applicable to mutual fund distributions and investor sales of securities for the period 2013 onward are outlined below. Keep in mind that investment income may also be subject to state and local taxation.
 * 1) Short-term capital gains distributions are made from realized gains on securities held for one year or less. Short-term gains are taxed at ordinary income tax rates up to 39.6%. Mutual fund short-term gain distributions are included in a fund's ordinary dividend distribution; therefore, capital losses may not be subtracted from these distributions when computing taxes.
 * 2) Long-term capital gains distributions are made from realized gains on securities held for more than one year. Long-term gains are taxed at 0% for taxpayers in the 10% and 15% tax brackets, at 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets, and at 20% in the 39,6% tax bracket. They are reported on tax Schedule D along with any other capital gains, and can be reduced by capital losses.
 * 3) Qualified dividends are the ordinary dividends that are subject to the same tax rate that applies to long-term capital gains. They should be shown in box 1b of the Form 1099-DIV you receive.
 * 4) When you sell at a loss you will either offset capital gains which would have otherwise been taxed at your capital gains rate or you will offset income (up to $3,000 maximum per year) which would have otherwise been taxed at your marginal income tax rate, or both. If you offset capital gains that would have otherwise not been taxed at all (because your capital gains tax rate is 0%) then this part of the tax loss harvest may be an outright loss.
 * 5) The Affordable Care Act imposes a Medicare surcharge of 3.8% on all net investment income (NII) once the taxpayer's adjusted gross income exceeds $200,000 (single) or $250,000 (married); while this tax is not part of the income tax, it has the same effect on investors as a higher tax rate. The NII tax begins to apply to individuals falling in the 33% tax bracket. Thus the top effective marginal tax rate is 23.8% on qualified dividends and long-term gains, 43.4% on ordinary investment income.

Tax analysis
The annual fund accounting figures show that the Vanguard Mid Cap Index fund, since its adoption of the MSCI mid cap index as its tracking index, has provided lower turnover ratios inhabiting a range between 16% to 24%. These ratios suggest a holding period for the portfolio stock holdings of between 4 to 6 years. This moderate turnover can be attributed to the fact that stock migration out of a mid cap blend index can come in the following dimensions:


 * 1) An individual company becomes relatively larger and migrates to a large cap index;
 * 2) An individual company becomes relatively smaller and migrates to a small cap index;
 * 3) An individual company is bought out or merged with a second company.

Shareholders have made net purchases of fund share since the fund's inception. Shareholder turnover, revealed in the Redemptions/Average Net Assets (R/ANA) metric, shows that shareholders, in years not affected by large shareclass conversion activity, have turned over their fund holdings at rates ranging from 18%-40%, suggesting holding periods of between 2 to 5 years. A considerable portion of fund assets is held in the ETF share class. The ETF R/ANA metric reveals substantial institutional creation and redemption activity in the fund.

A look at realized net gains/losses shows that the fund has, since the introduction of the ETF shareclass, realized net losses in each of the past five years (see the second tab, tax attributes in Table 3 above). These losses produce an ever increasing loss carryforward which can used to offset future realized gains.

The following table presents the federal tax cost on the fund's historical distributions (see second tab, table 6.) under the current tax regime (with dividends taxed at and long term capital gains taxed at tax rates of 0%, 15%, or 20% depending on marginal tax rate, and an additional 3.8% ACA Net Investment Income tax assessed at higher tax rates). Keep in mind that distributions can also be subject to state and local taxation, with marginal rates ranging from 0% to 12% (an average 5% state tax rate will add an approximate 0.07% to the annual tax cost of holding the fund.) The average is based on the results from 2004-2013, the period marked by the qualified dividend tax regime. The fund has realized higher dividend yields since it began tracking the MSCI Mid Cap Index in 2003. With no loss carryforwards and the higher turnover rates experienced by the fund's prior tracking index (S&P 400 index} the fund distributed an average per annum 2.49% short term capital gain and an average per annum 1.34% long term capital gain over the 1998-2003 period.

The table does not include the capital gains cost associated with selling the fund at a gain. This table indicates the additional cost for the capital-gains tax when you sell, assuming that you pay taxes on the distribution and reinvest the after-tax portion of the distribution; since it is a one-time cost, the effect is annualized. For example, if you hold an investment for 30 years and lose 10% to taxes when you sell, that is equivalent to losing 0.35% every year. Thus, if you sell the fund, your cost will be the sum of the Table 6 and Table 8 costs. However, you would not pay the Table 8 cost on any stock which you either leave to your heirs or donate to charity, and thus may not pay that cost on your full investment. In particular, you might estimate your total tax cost by using the low-return line in Table 8; if stock returns are high, you will have a large taxable account and will reduce the tax cost by taking longer to deplete it or by not spending it all during your lifetime.

Taxes are computed at a tax rate of 15% on long-term gains (except in the "rate rises to 20% column", which applies if that tax reduction is allowed to expire), and on qualified dividends (except in the "no QDI" column, which applies if the tax reduction on qualified dividends expires and the rate is 35%). Although not tabulated, keep in mind that investors in the lower tax brackets (15% or lower) pay lower federal tax rates on investment income for the period 2003 - 2013, and reap higher after-tax returns, outside of tax-exempt municipal bonds, in all asset classes.