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Distributions and Taxes

Fund distribution types and how they’re taxed

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 that may distribute based on their investments.

Types of Distributions

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.

How You Are Taxed

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.

Taxation of Capital Gains and Qualified Dividends

The Tax Cut and Jobs Act changed the income tax amount breakpoints for each of the reduced capital gain rates, and will now be indexed for inflation. 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.

LONG TERM RATE

MARRIED FILING JOINTLY*

SINGLE*

0%

 $0 to $78,750

$0 to $39,375

15%

$78,251 to $488,850

$39,376 to $434,550

20%

More than $488,851

More than $434,551

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.

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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.