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KNOW TAX FACTS ON MUTUAL FUNDS TO AVOID HASSLES WITH THE IRS

Tax procrastinators, take heart: The answers to these tax questions about mutual funds may help you save time - and maybe money - in finishing your 1994 return.

Question: I got nailed a few years ago when I reported earnings from a money-market mutual fund as interest rather than dividends. The IRS accused me of failing to report the income, and it was a real hassle getting things straightened out.In 1994 I invested in a tax-free mutual fund. Is the money I earned from the fund considered interest or dividends?

Answer: You can't accuse the IRS of consistency. When taxable interest earned by a money-market mutual fund is passed to shareholders, it must be reported as dividends. When tax-free interest earned by a municipal-bond mutual fund goes to shareholders, it must be reported as tax-exempt interest.

You should list it on line 8b of your Form 1040.

Question: In the past, I've used the first-in-first-out method for determining the basis of mutual fund shares I redeemed.

Is it okay to switch to the specific-identification method? I think it would save me some money this year.

Answer: You can switch between FIFO and specific identification, but only if you alert the fund before you redeem the shares.

To use the specific-identification method, you must direct the fund to redeem certain shares (such as the 100 shares purchased on July 2, 1990, at $17.66 per share) and get written confirmation from the fund.

A different rule applies if you use the average-basis method for figuring the gain or loss: Once you use it, you must continue to use it as long as you have money in the fund.

Question: I sold shares in a tax-free fund last year and, like just about everyone else, lost money on the deal.

Can I deduct the loss even though income from the fund is tax-free? Or is that double-dipping?

Answer: Dip away. If you got less for your shares than you paid for them, you have a tax-saving capital loss. Report it on Schedule D, where you can use it to offset any capital gains you scored during 1994.

Up to $3,000 of excess loss can be deducted on the Form 1040 to offset other income, including part of your salary.