Reinvested fund dividends: Keep track and keep IRS happy

Dollars & Sense

April 22, 2001|By Neil Downing | Neil Downing,THE PROVIDENCE JOURNAL

We receive dividends from a mutual fund that are reinvested, and then when we sell the shares we pay a capital gains. How do we keep track of all these dividend reinvestments so that we don't have to pay the tax on that?

Some taxpayers do it with pencil and paper, others by computer. But always remember to keep track. Why? If you own shares in a mutual fund outside a tax-sheltered account, the dividends your fund pays get taxed - even if you reinvest them to buy more shares.

Your fund mails you a form each year. It shows how much in dividends you were paid. You must report these dividends on your federal tax return. They're taxed as ordinary income, at rates as high as 39.6 percent, said Robert J. Sclama, who runs a financial planning and tax consulting business in North Providence, R.I.

When you sell your shares, your taxable profit is generally the difference between how much you paid for the shares (your "basis") and how much you receive. When it's time to account for any profit or loss, be sure to add to your basis the amount of dividends you reinvested over the years.

Suppose you invest $5,000 in a fund that pays you $100 in dividends each year for five years, all of which you reinvest. You sell your shares for $8,000. If you forget about the reinvested dividends, your taxable profit will be $3,000, but it will be $2,500 if you count the $500 in dividends you reinvested.

Keep records to show the Internal Revenue Service should it examine your return. Keep a file of the account statements and tax forms your fund sends you. Also consider keeping a running tally of all the dividends you reinvest, to make things easier at tax time.

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