Definition: Dividends are payments to shareholders (investors) of stocks, bonds, or mutual funds. These payments represent a company's profit that is divided among the shareholders. Mutual fund investors will choose if they want dividends to be reinvested (to buy more shares of the fund) or to be received as cash payment or deposited into another account.
Taxation: It is important to note first that mutual fund shareholders can be taxed on a fund’s dividends, even if these distributions are received in cash or reinvested in additional shares of the fund. Also, for certain tax-deferred and tax-advantaged accounts, such as an IRA, 401(k) or annuity, dividends are not taxable to the investor while held in the account. Instead, the investor will pay income taxes on withdrawals during the taxable year the distribution (withdrawal) is made. Some mutual funds, such as Municipal Bond Funds may pay income to shareholders that is exempt from federal taxation.
For taxable accounts, such as individual and joint brokerage accounts, mutual fund dividends are generally taxed either as ordinary income (taxed at the individuals income tax rate) or as qualified dividends (taxable up to a 15% maximum rate). Ordinary and qualified dividends are reported to mutual fund investors on the tax Form 1099-DIV. For tax filing purposes, the mutual investor (taxpayer) will report dividends on Form 1040, Schedule B, and Form 1040, lines 9a and 9b.
See Also: Dividend Mutual Funds
For more information, you may want to contact your tax adviser or refer to IRS Publication 550.
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