Each year, typically in January or February, but sometimes as late as early April, you can expect to receive a late Christmas present from each of your dividend stocks and mutual funds: a 1099-DIV. The 1099-DIV reports all your taxable income distributions from the fund so you can account for them appropriately on your tax return. If your present doesn’t arrive, contact the fund company for the information.
The following paragraphs describe the contents of certain elements of this form so that you can gain a clearer understanding of how these amounts are taxed.
Box 1a. Total ordinary dividends
The amount in this box represents all dividends (both qualified and unqualified) paid by the fund.
Box 1b. Qualified dividends
If your mutual fund owns stock in companies that pay qualified dividends, a portion or all of the total ordinary dividends reported in box 1a may appear in box 1b, depending on how long the fund held its shares. Remember that these figures represent the dividends that qualify for the mutual fund. To determine whether they qualify for you, head to the earlier section “Meeting the holding-period requirement.”
Box 2a. Total capital gain distribution
Box 2a is guilty of a misnomer. Instead of being called “total capital gain distribution,” it should be labeled “total long-term capital gain distribution” because the fund’s short-term capital gains are reported as unqualified dividends.
Capital gains inside mutual funds are just like capital gains in individual stocks. If a fund sells a stock for more than it paid for its shares, the profit is a capital gain. If the fund held the sold asset for more than one year, the profit is treated as a long-term capital gain.
Even though you haven’t cashed out your fund shares and regardless of whether those long-term capital gains were reinvested or distributed to shareholders, you need to pay taxes on them.
Don’t get stuck paying taxes on gains you never received. Mutual funds may earn capital gains throughout the year, but they distribute their long-term capital gains only at the end of the year. Although this setup may seem like a positive to the guy who buys late in the year, it’s not. Any capital gain distribution lowers the mutual fund’s net asset value (NAV). If you buy near the end of the year and receive the distribution, but the fund’s share price drops, you end up even. However, you may still get stuck paying taxes on these gains that left you cash neutral. Before buying a mutual fund late in the year, check its capital gains distribution date.