Adjust your fund portfolio to ease '93 tax burden And check '92 return to avoid overpaying PERSONAL FINANCE

MUTUAL FUNDS

March 07, 1993|By Werner Renberg | Werner Renberg,1993 By Werner Renberg

If you're invested in mutual funds outside of an IRA (or other tax-sheltered retirement account), it's time to assemble fund statements and other documents for your 1992 income tax forms.

You can do little to cut the tax bill for the income and capital gains that fund investments produced last year, except to figure your taxable income properly so that you don't pay more than you should.

(If you can make a tax-deductible contribution to an IRA and haven't already mailed the return, of course, you have until April 15 to do so.)

But it's not too early to consider how you might adjust your fund portfolio to hold down, if not reduce, your tax burden for 1993.

1992 distributions

Last year may have been a flat year for your bond and equity funds -- even a down year for one of your equity funds -- but the IRS won't show any sympathy. Your income dividends (except for those of tax-exempt funds) and capital gains distributions constitute taxable income, whether you took them in cash or reinvested them.

The Form 1099-DIV that you recently received shows the gross dividends, ordinary dividends, and capital gains distributions that you were credited with or paid. Depending on whether they exceeded $400, you report them on Form 1040 or on Schedules B and D.

(Note: Dividends from tax-exempt bond funds must be reported on Form 1040, even though they're not federally taxable.)

As you go over the amounts, you may find some surprises.

Your municipal bond fund, in which you invested to earn federally tax-exempt income, may have paid a capital gains distribution that you had not expected -- and on which you will have to pay income tax.

Or an equity fund, in which you invested for growth, may have distributed an above-average taxable income dividend for some reason.

Take, for example, Strong Discovery Fund, a leading five-year performer that seeks maximum capital appreciation. After paying low dividends in 1989 and 1990 and none in 1991, it paid $1.50 per share in 1992 -- a rate of 9 percent, which exceeds those of most bond funds.

The explanation: Portfolio manager Richard S. Strong had realized such large short-term capital gains that he had to act to avoid violating the "short-short" rule, which requires funds to pay taxes if short-term capital gains exceed 30 percent of their income.

His solution: Buy high-yield securities before the record dates for their dividend/interest payments and then sell them (after their prices are reduced by these amounts) to generate short-term losses. This fattened the fund's investment income -- and, thus, its dividend.

Capital gains, losses

If you sold fund shares during 1992, be sure to calculate your short- and/or long-term capital gains or losses correctly.

Form 1099-B reminds you how much you received for the shares, but it's up to you to figure out your gains or losses.

They depend on your method of determining the cost of shares sold -- including those bought with reinvested income and capital gains distributions. Many investors overlook the latter, thus understating their costs and overstating their gains.

If you choose the average-cost method, your job may now be easier -- provided your fund companies send you annual statements containing average-cost data for redeemed shares.

IDS began to provide such information to shareholders as long ago as 1972, after helping to convince the IRS to accept average-cost as a basis for calculating gains or losses. It was not until recent years, though, that other fund families sent out such statements.

A bill before Congress would require all to do so.

Information

While you may need to consult a tax adviser, you can get a lot of helpful, free information from the IRS (Publication 564) or from fund families such as Fidelity, Financial Funds, T. Rowe Price, Putnam, and SteinRoe. Vanguard's comprehensive guide costs $5.

1993 tax planning

Whether or not you wind up in a higher tax bracket this year, think about modifying your fund portfolio to enhance your return.

Keep in mind not only your probable tax costs but also the importance of staying on course toward your investment goals while avoiding unnecessary risks.

As you consider the equity funds in which you've invested for growth, remember that funds paying good -- but taxable -- dividends also are likely to be less volatile than diversified or sector funds that pay low dividends or none.

And whether you're in bond funds to diversify a growth-oriented portfolio or for income, do calculate the consequences of investing in a taxable or a tax-exempt fund.

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