Ch 8: Investment Cos Part II (Taxes, Interest) Flashcards
What’s subject to income tax?
salaries, bonuses, commissions, tips, dividends, and interest. Normally taxed as odinary income.
If theere was a gain, tax must be paid on it. Loss? It caan be used to offset gains and income.
MFs receive income in thee form of…
dividends from stocks in which they invest and interest from bonds
MFs may pay dividends to each shareeholder in the same way corps pay dividends to stockholders. Thee Investm Co Act requires a wrritten statement to accompany dividend payments by mgmt companies.
MF dividends arre typically paid from the MF’s net investm income, usually on a QUARTERLY BASIS.
Qualified vs Nonqualified dividends’ taxing
qualified - taxed at lowerr LT capital gains rate
Nonqalified divid - taxed as ordinary income
NII
Net Investment Income
NII = DIVIDENDS + INTEREST - EXPENSES OF FND
so NII = D + I - E
advertising and sales expenses aree NOT including in fund’s op expenses when calcualitng NII, but mgmt fees, custodian bank charges, and legal and acct fees are included
*** bond fund does NOT pay interest to investors. Investors…
buy common stock of the bond fund and, therefore, wil receive a dividend if declared. Even tho it’s a dividend, bc the source is interest it is taxed as interest.
That’s why you can receive a dividend from a muni bond fund that’s tax-free.
Conduit Theory
Triple taxation of investment income can be avoided if the MF qulaifies under Subchapter M of the IRC. If a MF acts as a CONDUIT (pipeline) for the distribution of NII, the fund may qulaifify as a REGULATED INVESTMENT CO (RIC).
This means it’s subj to tax only on the amt of NII the fund retains. The protion of the nII distributed to shareholders expcapes taxation at the MF level.
TO avoid taxation under SUbchapter M, a fund must distribute at least 90% OF ITS NII TO SHAREHOLDERS. The fund then pays taxes only on the undsitributed income.
***Fund will only distribute its LT capital gains. Because of the conduit nature of the distribution, the IRS says investors always report these on their tax returns as LT capital gains.
Most closed-end comapnies, including BDCs, qualify as…
RICs for the tax benefit to investors
MF Capital Gains Distribution
appreciation/depreication of portfolio secs is unrealized capital gain/loss if thee fund does not sell the secs. Thereforee, shareholders experience no tax conseuqneces.
When the fund sells the scs,the gain/loss is realized. A realized gain is an actual profit made.
Capital gains distributions are derived frorm net realized gains (the fund compares its realized gains and losses to determine the net result). The disctinion between LT and ST is the same as for any investment.
