Stock ownership comes with a price -- capital gains tax

Mutual Funds

Number paying levy has doubled this decade

February 21, 1999|By DALLAS MORNING NEWS

Paying capital gains taxes once fell primarily on the well-heeled, but the number of Americans required to pay the tax has almost doubled this decade.

Capital gains are typically generated when assets such as stocks, mutual funds, bonds, jewelry and artwork are held for a year and sold. The number of tax returns reporting capital gains has increased from 9.2 million in 1990 to about 18 million in 1997, or from about 6 percent of all individual returns filed to 10 percent, according to the U.S. Treasury Department.

The reasons for the increase are the growth in stock ownership and increased market volatility, said Mark Luscombe, a tax analyst at Chicago-based CCH Inc., a tax law research company.

"When the market is going up steadily, people are comfortable holding on" to their stocks, Luscombe said. "But when it turns volatile, investors start selling and try to get out before a big loss, and that creates capital gains."

In 1980, 6 percent of U.S. households owned mutual funds, compared with almost 40 percent today, according to the Investment Company Institute.

That translates into about 40 million U.S. households that own mutual funds, and when added to those who hold individual stocks, about 100 million Americans have a stake in the stock market.

Given the generally upward trend of the stock market in recent years, most of them will have to grapple with capital gains unless the stocks are held in tax-deferred retirement accounts, such as 401(k)s.

Congress has simplified the rules governing capital gains for last year, and it also reduced the tax rate on these gains from 28 percent to 20 percent for taxpayers in higher income brackets, and to 10 percent for those in the 15 percent tax bracket.

In addition, the confusing holding periods and different rates of 1997 have been eliminated for last year's returns, Luscombe said.

Most mutual fund shareholders are aware that capital gains are generated when they sell shares. Many are surprised to learn that they might generate capital gains on mutual fund shares that they didn't sell or declined in value, said Elliott Eiss, editor of J.K. Lasser's Your Income Tax Guide.

That's because mutual fund managers often buy and sell stocks within their funds, and that generates capital gains and sometimes capital losses.

In other words, though individual investors make no changes in their investments, mutual fund companies buy and sell stocks continually, creating so-called taxable events.

The amount of the gain and other dividends are listed on IRS Form 1099 and mailed to shareholders in late January and early February.

For those who sell mutual fund shares, determining which shares are sold is sometimes confusing.

For example, an investor might buy 100 shares of a mutual fund at $15 a share, paying $1,500. Six months later, he buys another 100 shares at $25 a share, paying $2,500. Suppose a year passes, the fund's share price falls to $22, and the investor then sells 100 shares, receiving $2,200.

Does the investor have a capital gain or loss?

It depends on which shares were sold. If the investor had the presence of mind to instruct the fund company to sell the shares he purchased for $25 and received written confirmation that those were the shares sold, then it's a $300 capital loss.

But unless they are instructed to sell specific shares, some fund companies will compute the average cost of all shares owned by an investor in the fund from which shares are being sold, in this case $20 a share, resulting in a capital gain of $200.

If the mutual fund company doesn't provide average cost information, investors must do their own arithmetic if they want to use that method of computing the cost of the shares they own.

Investors with capital gains must attach an IRS Schedule D (Capital Gains and Losses) with their tax returns.

If capital losses exceed capital gains, the IRS allows as much as $3,000 in capital losses to offset ordinary income. Losses greater than this amount have to be carried over to future years.

Pub Date: 2/21/99

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