Tax season is always difficult for mutual-fund investors. This year, the difficulty will start with a capital D.
All investors with money in taxable funds will have to complete the dreaded Schedule D form when they prepare their 1997 returns. Though active traders have long been required to do this penance, they’re about to start sharing their misery with millions of buy-and-hold investors whose only capital gains are fund distributions.
Most mutual-fund companies say they intend to help shareholders cope with this and other changes arising from the Taxpayer Relief Act of 1997, which was signed into law by President Clinton in August. But the amount and quality of assistance is sure to vary. As Mark Luscombe, principal analyst for the federal and state tax group at CCH Inc. in Riverwoods, Ill., puts it: “Funds are going to be providing lots of supplemental information this year, and investors have a vested interest in making sure they get the help they need.”
Under the new law, long-term capital gains are now taxed at several different rates depending on how long an asset was held, and when it was sold. But the rates also apply to gains within a fund. These gains are parceled out to shareholders at least once annually. Funds have until Saturday to tell shareholders how large a taxable distribution they received in 1997. The information appears on Form 1099-Div.
But this year, the reporting of capital gains distributions will be far more complex. That’s because the standard Form 1099-Div hasn’t caught up with the new law. It lists short-term gains separately, but lumps all long-term gains together. Yet, long-term gains must now be divided into at least two buckets: the “20 percent rate gains” (on stocks held longer than 18 months) and the “28 percent rate gains” (on stocks held more than 12 months but less than 18 months).
Most fund groups and brokerage firms haven’t told shareholders how they are going to handle the sorting out of long-term gains, though they acknowledge investors have been calling toll-free lines to find out what’s in store.
Vanguard Group, which manages $324 billion in fund assets, has announced that it will calculate the 28 percent rate gains for fund shareholders and report the sum as a footnote on Form 1099-Div. Like some other major fund companies, Vanguard sends out a customized version of the form, showing the necessary information for each fund separately.
Joel M. Dickson, Vanguard’s tax maven, says that in situations in which a single fund makes more than one distribution, Vanguard will combine the portion of each payment that is a 28 percent gain to show only one figure.
Fidelity Investments and T. Rowe Price Associates say they have similar plans.
But plenty of other fund groups are likely to leave shareholders to do the addition–and perhaps also some serious multiplication.
DST Systems Inc., the Kansas City, Mo., company serving as a behind-the-scenes record-keeper for more than 235 fund groups, probably will provide shareholders with “enclosures and attachments” to the 1099-Div, listing the portion of each fund distribution made up of 28 percent rate gains. An investor would then apply this factor to the total long-term gains figure on his 1099. This could get messy if, say, 45 percent of a fund’s March distribution, and 10 percent of its December distribution, is made up of 28 percent gains.
“The changes under the new law all came about so quickly,” laments Randy Gore, a DST vice president, “there wasn’t much time for us to prepare.”
Investors in real-estate mutual funds are bound to have to wait even longer than the usual Jan. 31 deadline. That is because these funds generally consist mainly of real-estate investment trusts, or REITs, which are now a true tax nightmare. Unlike regular funds, which must divide gains distributions into three categories–the usual short-term plus two levels of long-term–real-estate funds also have to separate other categories of gains and income from the REITs they hold.
The additional buckets include depreciation recapture (now taxed at a new 25 percent rate) and any non-taxable return of capital. Because the REITs don’t report this information until January, most real-estate funds can’t send out the 1099-Div until late February. (The Internal Revenue Service typically provides an extension.)
One way to avoid dealing with such last-minute tedium is to hold real-estate funds only in tax-deferred accounts.
