Capital gains distribution

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A capital gains distribution occurs when mutual funds, closed-end funds, and exchange-traded funds (ETFs) make distributions to shareholders from the capital gains realized in their investment portfolios. For investors holding funds in taxable accounts, these distributions are taxable, the rate of taxation dependent on how long the fund has held the investment and the individual taxpayer's marginal tax rate. The two types of distributions that apply to stock and bond funds are termed short-term gains and long-term gains. [note 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 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.
  • Long-term capital gains distributions are made from realized gains on securities held for more than one year. They are reported on tax Schedule D along with any other capital gains, and can be reduced by capital losses.

Typically, funds distribute capital gains near the end of the year in December. Investors holding funds in taxable accounts are usually advised to invest new funds after a fund has made its capital gains distribution. This avoids the needless purchase of a tax liability.

Capital gain rates for 2018 and beyond

For the tax year 2018, and for subsequent years, short-term gains are taxed at ordinary income tax rates up to 39.6%. For taxpayer's subject to the Net Investment Income (NII) tax, rates are described at the bottom of the first table below.

The taxation of long term capital gains also changes beginning in 2018. Rates for qualified dividends are listed in the second table below. Note that the long-term capital gain rates do not align with the ordinary income tax rates ("tax brackets") shown in the first table.

Filing status and annual taxable income - 2018 Ordinary income tax rate Long-term capital gain rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates Collectibles and certain small business stock[* 1] Unrecaptured Section 1250 gain
$0-$9,525 $0-$19,050 $0-$9,525 $0-$13,600 $0-$2,550 10% 10% 10%
$9,526-$38,700 $19,051-$77,400 $9,526-$38,700 $13,601-$51,800 n/a 12% 12% 12%
$38,701-$82,500 $77,401-$165,000 $38,701-$82,500 $51,801-$82,500 n/a 22% 22% 22%
$82,501-$157,500 $165,001-$315,000 $82,501-$157,500 $82,501-$157,500 $2,551-$9,150 24% 24% 24%
$157,501-$200,000 $315,001-$400,000 $157,501-$200,000 $157,501-$200,000 n/a 32% 28% 25%
$200,001-$500,000 $400,001-$600,000 $200,001-$300,000 $200,001-$500,000 $9,151-$12,500 35% 28% 25%
$500,001+ $600,001+ $300,001+ $500,001+ $12,501+ 37% 28% 25%
  1. Collectibles are defined in 26 USC 408(m). Small business stocks are per Section 1202. Reference: Alistair M. Nevius (May 1, 2013). "Qualified small business stock". Journal of Accountancy. https://www.journalofaccountancy.com/issues/2013/may/20137453.html.

In addition, there is a 3.8% Medicare tax rate on investment income in excess of an adjusted gross income of $200,000 ($250,000 for married filing jointly), and 0.9% on salary and self-employment income in excess of this level. See: ACA net investment income tax

Filing status and annual taxable income - 2018 Long-term capital gain rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates Qualified dividends and other investments
$0-$38,600 $0-$77,200 $0-$38,600 $0-$51,700 $0-$2,600 0%
$38,601-$425,800 $77,201 - $479,000 $38,601-$239,500 $51,701-$452,400 $2,601-$12,700 15%
$425,801+ $479,001+ $425,801+ $452,401+ $12,701+ 20%

Capital gain rates prior to 2018

For the tax years 2013 through 2017, short-term gains are taxed at ordinary income tax rates up to 37%. For taxpayer's subject to the Net Investment Income (NII) tax, a 3.8% surtax for taxpayers whose adjusted gross income surpasses threshold limits,[note 2] the maximum tax rate increased to 43.4%.

Beginning in 2013, the taxation of long term capital gains also changed. Long-term gains are taxed at 0% for income which would be in the 10% and 15% tax brackets, and at 15% for income which would in be the 25%, 28%, 33%, and 35% tax brackets. For income which would be in the 39.6% marginal tax bracket, the capital gains tax is 20%. For taxpayers subject to the Net Investment Income (NII) tax, the capital gains tax increased to 18.8% and 23.8%.

The NNI tax threshold levels begin to effect taxpayers whose adjusted gross income falls in the 33% marginal tax bracket, and affects all taxpayers in the 35% and 39.6% marginal tax brackets.

Below is a summary of previous capital gain rates.

Summary of recent history
July 1998 – 2000 2001 – May 2003 May 2003 – 2007 2008–2012 2013–2017
Ordinary Income Tax Rate Long-term Capital Gains
Tax Rate
Ordinary Income Tax Rate Long-term Capital Gains
Tax Rate**
Ordinary Income Tax Rate Long-term Capital Gains
Tax Rate
Long-term Capital Gains
Tax Rate
Ordinary Income Tax Rate Long-term Capital Gains
Tax Rate
15% 10% 10% 10% 10% 5% 0% 10% 0%
15% 10% 15% 5% 0% 15% 0%
28% 20% 27%* 20% 25% 15% 15% 25% 15%
31% 20% 30%* 20% 28% 15% 15% 28% 15%
36% 20% 35%* 20% 33% 15% 15% 33% 15%***
39.6% 20% 38.6%* 20% 35% 15% 15% 35% 15%***
39.6% 20%***

* This rate was reduced one-half percentage point for 2001 and one-half percentage point for 2002 and beyond.
** There was a two percentage point reduction for capital gains from certain assets held for more than five years, resulting in 8% and 18% rates.
*** The gain may also be subject to the 3.8% Medicare tax.

See also

Notes

  1. Special tax considerations are also applicable to commodity asset classes and fund structures:
    • Precious metals and grantor's trusts: the IRS considers precious metals to be collectibles. Thus, precious metal ETF's, as well as bullion, are subject to a maximum 28% long term capital gains tax rate and a maximum short term 39.6% tax rate.
    • Commodity futures are subject to a 60/40 long term/short term blended tax obligation. Thus they have a maximum 23% long term capital gains tax rate and a maximum 23% short term maximum tax rate. Limited partnership ETFs are considered pass-through investments. Each year gains are marked-to-market and passed through to investors as a potential taxable obligation regardless of whether the shares are sold or held.
    • Exchange traded notes based on equity investments are subject to a 15% or 20% long term capital gains rate, depending on marginal tax rate, and a maximum 39.6% short term capital gains rate.
      Source:The Complete Guide to ETF Taxation, indexuniverse.com, (November, 2011)
  2. The threshold amounts are $250,000 for married filing jointly/ surviving spouse with dependents; $200,000 for single/head of household; and $125,000 for married filing separately. The threshold amounts are not indexed to inflation.

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