UNIT 02.03-002 Flashcards
Mutual fund shareholders are not taxed on
____________ capital gains.
unrealized capital gains.
Interest, dividends, and realized capital gains are all taxed. However, unrealized capital gains are not taxed. Unrealized gains contribute to NAV appreciation and to a shareholder’s capital gain upon redemption.
In July, a customer invested $10,000 in the ABC Mutual Fund. In December of the same year, ABC announced a long-term capital gains DISTRIBUTION.
In May of the next year, the customer decided to REDEEM his shares for a capital gain.
How are both of the capital gains treated for tax purposes?
The capital gain distribution is treated as long term.
The capital gain from redemption is treated as short term.
When long-term capital gains are distributed, the length of time an investor has owned the fund is not relevant; it’s still a long-term distribution. However, redemption of shares follows the normal holding period rules. Therefore, when this customer sold shares 10 months (July to May) after the purchase, the gain, like any other gain from a holding period that does not exceed 12 months, is short term.
Which of the following statements regarding taxable investment company distributions to investors is true?
Dividend distributions are reported on IRS Form _____-DIV.
Dividend distributions are reported on IRS Form 1099-DIV.
Investment company distributions are reported to shareholders on IRS Form 1099-DIV.
Dividends are paid as declared by the board of directors; capital gains are paid annually.
Dividends, not capital gains, are paid from the company’s net investment income.
Capital gains are generated when an investor redeems appreciated shares of the investment company and when portfolio securities are sold.
When calculating net investment income, an investment company includes
_____+ interest - minus operating expenses.
dividends + interest - minus operating expenses.
Net investment income equals gross investment income minus operating expenses. Gross investment income is interest and dividends received from securities in the investment company’s portfolio.
The pipeline theory of taxation helps mutual funds reduce the impact of what?
Triple taxation
The pipeline (or conduit) theory eliminates one taxation level of the three that impact dividends. The money used to pay a mutual fund dividend is still taxed at the original corporate level and again at the individual taxpayer level (double taxation) but avoids taxation at the fund level, thus avoiding triple taxation.
Your father purchased $10,000 of ABC stock 10 years ago and purchased an additional $5,000 on April 1.
On September 1, when the current market value of the stock is $25,000, your father passes away and you inherit the ABC stock.
On November 1, you sell the stock for $30,000. What do you report on your tax return?
$5,000 long-term capital gain
The holding period for stock inherited is always long term, no matter when the stock was purchased.
The cost basis of the stock is automatically stepped up to the current (fair) market value at the time of death.
Therefore, the cost basis for the stock is $25,000, and when it is sold for $30,000 (two months later), it will result in a $5,000 long-term capital gain.
Customer A and Customer B each have an open account in a mutual fund that charges a front-end load. Customer A has decided to receive all distributions in cash, while Customer B automatically reinvests all distributions. How do their decisions affect their investments?
Receiving cash distributions may reduce Customer A’s proportional interest in the fund.
Customer B’s reinvestments purchase additional shares at NAV rather than at the offering price.
If the customer elects to receive distributions in cash while other investors purchase shares through reinvestment, his proportional interest in the fund will decline. Automatic reinvestment is always at NAV.
The Brandon Equity and Income Fund holds a mix of stocks and bonds. In the current year they received $1,000,000 in dividends from stocks and $600,000 in interest from bonds. Over the year they have had $100,000 in expenses. What is the fund’s net investment income?
$1.5 million
The formula for net investment income is dividends + interest – expenses. $1,000,000 + $600,000 = $1.6 million. $1.6 million – 100,000 = $1.5 million.
Which of the following statements is true for an individual calculating taxes on distributions she received from a municipal bond fund for this year?
Any capital gains distributions she received from the fund are taxable at capital gains rates.
Interest in the form of dividends paid from a municipal bond fund would be exempt from federal income tax. Capital gains distributions from the sale of portfolio securities would be subject to capital gains taxes.
The KPF Growth and Income Fund experienced $10 million in net investment income last year. Of this, it distributed $8.9 million to its shareholders. On how much of its net investment income must the fund itself pay income tax?
$10 million
If a mutual fund distributes at least 90% of its net investment income to its shareholders, it need pay taxes only on the income it retains. If it distributes less (in this case, it distributed 89%), it must pay income tax on 100% of its net investment income. In either case, the shareholders pay income tax on what they received.
