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Taxes May Blindside Investors

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The Associated Press

Published: November 16, 2008

CHICAGO - Talk about kicking investors when they're down.

A required year-end practice by mutual funds is about to whack many people with capital gains taxes when funds already have declined by as much as 40 percent this year.

Even though a fund's value has declined, it may have realized capital gains over the course of the year - profits from selling specific securities in the portfolio.

But when individuals find out they have to pay taxes for gains in one of the worst years in stock market history, it's likely to stir shock or outrage among those who pay little attention to the process.

After all, 99.9 percent of all U.S. equity open-end funds had negative returns for 2008 through Oct. 31 and the average fund had lost 35 percent, according to Morningstar Inc.

"Even though we've experienced a great deal of losses as investors this year, we could have fairly sizable distributions passed through to us," said Tom Roseen, an analyst with fund tracker Lipper. "What an insult on top of injury."

The Internal Revenue Service requires mutual funds to distribute substantially all of their income to their shareholders, who must then report the distributions as income and pay taxes on them. This year, funds realized gains from stocks sold before their value plummeted this fall.

If your fund investments are in tax-sheltered retirement vehicles such as 401(k)s or IRAs, you needn't be concerned. But shareholders of other funds face what could be a significant double whammy with ill-timed distributions on top of whopping personal losses.

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