Markets Down, Taxes Up

By Janet Novak / Forbes

Stocks are having a rotten year. Federal capital gains and dividend tax rates are at historic lows. Yet as they complete their 2007 1040s, individual investors are paying the biggest tax bill ever on distributions of capital gains and dividends from their mutual funds.

Lipper Senior Analyst Tom Roseen, who plans to release his widely watched annual tally of fund taxes on April 15th, told Forbes.com that his preliminary calculations show investors' 2007 tax tab will top the record $31.3 billion they paid for 2000. "It's going to be monstrous,'' he says. "This is the year people are going to wake up and go 'wow, taxes matter again,' '' he adds.

Roseen's report isn't about the taxes investors pay when they sell mutual fund shares for a profit. Rather, he tracks the tax burden from the unique--and some argue unfair--tax code treatment of mutual funds.

Funds don't pay taxes themselves, but must distribute at least 90% of their net gains annually to shareholders. When an investor holds fund shares in a taxable account--as opposed to a tax-deferred one, such as an IRA or 401(k)--he pays tax each year on those distributions. That's true even if he has all those payouts automatically reinvested in the fund. By contrast, an investor who owns individual stocks in a taxable account doesn't have to pay capital gains tax until he actually sells the shares, giving him a greater ability to minimize his tax bill.

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