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Taxes can have a big impact to your bottom line, so it's important to understand how tax rules and concepts affect your investments.
The Tax Cut and Jobs Act passed in late 2017 changed many of the tax provisions in the tax code, in an effort to simplify the tax code. Below, we provide a summary of the provisions most relevant to mutual fund investors. Please note that some of these provisions will sunset after 2025, which means those provisions revert back to "pre-Act" rates after that date, unless Congress acts again to extend them or make them permanent.
The income tax rate brackets have been reduced, with the new top rate of 37%. The income ranges for each bracket will be indexed for inflation going forward, and the reduced income tax rate brackets will sunset after 2025.
The Alternative Minimum Tax is a parallel tax system that was created to keep high income individuals from avoiding taxes through various deductions and exemptions.
The exemption amounts are increased as shown below and will be indexed for inflation going forward. This provision sunsets after 2025, indexed for inflation.
The Tax Cut and Jobs Act doubled the Estate and Gift Tax Exemptions from $5 million to $10 million, adjusted annually for inflation.
Estate assets are taxed at the top rate of 40% with an exemption limit of $11.40 million for 2019 (based on the estate's value as of the decedent's date of death, including adjustments). This amount will be indexed annually for inflation.
While the Tax Cuts and Jobs Act does not specifically mention the Generation Skipping Tax exemption, since that exemption follows the base exemption for estates, that exemption was also increased. This provision will sunset after 2025, indexed for inflation.
A qualified charitable distribution (QCD) is a tax-free distribution from an IRA to a qualified charity. QCDs can be used to satisfy an investor's required minimum distribution (RMD) up to $100,000 per taxpayer, per taxable year. To request a QCD, please use this form .
Keep these QCD rules in mind:
Contact a tax advisor or visit the IRS website for more details about QCDs.
* Per the IRS, a SEP or SIMPLE IRA is considered active if it has been maintained under an employer arrangement under which an employer contribution is made for the plan year ending with or within the IRA owner's taxable year in which charitable contribution would be made.
The Tax Cuts and Jobs Act eliminated the tax provision allowing for Roth Conversions to be recharacterized back to a Traditional IRA effective in 2018. Per the Internal Revenue Service, Roth Conversions performed in 2017 can be recharacterized back to a Traditional IRA up to the 2017 tax filing deadline, plus extensions (Oct. 15, 2018). This a permanent change to the tax regulations.
Participants in 401(k), 403(b) or 457(b) Plans can convert any amount in a non-Roth account to a Roth account if the plan permits. The requirement that an account balance can only be converted to Roth if the amount is otherwise distributable is being eliminated. This is a permanent provision, effective for transfers after December 31, 2012.
The Net Investment Income Tax went into effect on January 1, 2013. The 3.8% Net Investment Income Tax applies to individuals, estates and trusts that have certain investment income above certain threshold amounts. Visit www.irs.gov for more information.
The annual contribution limit for CESAs is fixed at $2,000. The contribution deadline for this account type is April 15th of the following year.
Fund distributions can generate questions, especially at tax time. Mutual funds must distribute at least 98% of their annual income to investors for the funds to avoid taxation. Learn about four types of income funds may distribute based on their investments.
Keep in mind, the amount of a distribution can increase when the dividend payments or profits increase. A fund's capital gain distribution, however, is not necessarily a reflection of its overall performance.
When a mutual fund makes a profit from the sale of investments in its portfolio, it generally passes the profit on to you in the form of capital gains. Long-term capital gains are gains on securities owned by the fund for more than one year.
A mutual fund earns dividends, interest and other investment income on the securities in which it invests. After a fund subtracts its expenses from the investment income, it distributes the remainder to you as an ordinary income distribution.
The IRS requires that ordinary income distributions include any short-term capital gains (gains on securities owned by the fund for one year or less) realized and distributed by the fund. That means, your short-term capital gains and ordinary income will appear combined in the same box on your tax form.
A special category called "qualified dividends" applies to dividends paid on stock investments. The mutual fund will pass through to investors any qualified dividends it receives from stocks in the fund's portfolio. Short-term capital gain amounts may also be categorized as qualified dividends.
Interest from state and local municipal bonds is exempt from federal taxes and generally is exempt from state taxes in the state in which the bonds were issued. Mutual funds that invest in these securities generally distribute tax-exempt dividends to their investors.
A return of capital distribution is not considered income, rather it is a return of your original investment dollars and is nontaxable.
Distributions generally are subject to federal income taxes and may be subject to state and local taxes, whether you reinvest them or take them in cash. The tax status of a capital gain distribution is determined by how long the mutual fund held the underlying security that was sold, not by how long you have been invested in the fund.
Note: At the time distributions are paid, the type of income may not be fully known. The distribution classification for tax purposes will be determined at the end of each Fund's tax year and appear on Form 1099-DIV. For this reason, amounts shown on your statements and your tax forms may differ.
Your tax bracket determines how much tax you will owe on long-term capital gain distributions, as shown in the table below.
This category also includes short-term capital gains. You will owe tax on these distributions at the rate of your ordinary income tax bracket.
Qualified dividends are taxed at the long-term capital gain rates, as shown in the table below.* They may also include short-term capital gains. To qualify for these reduced rates, you must own the mutual fund shares for a period of 61 days or longer. That period must include the date the fund distributed the dividends.
While the dividends may be tax exempt, a portion of the income may be an adjusting item for the Alternative Minimum Tax. It also is possible to have taxable capital gains from investing in tax-exempt bond funds since bond prices fluctuate in response to changing interest rates. By selling bonds at a profit, a fund can generate capital gain distributions that may be subject to federal and state income taxes.
Based on the income from investments from foreign corporations, the fund pays taxes to foreign governments. These taxes are passed through to individual investors, who can take a credit against their U.S. federal income tax provided they meet certain requirements. You may review the fund's annual report for information regarding the foreign tax calculation at the fund level.
Because this type of distribution is a return of your original investment dollars it is nontaxable. Your cost basis should be reduced by the same amount as the distribution.
*The changes made by the Tax Cut and Jobs Act will sunset after 2025, and the income rates will revert to pre-2018 income tax rates and amount thresholds, adjusted for inflation.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.