The objective of every investor is to maximize the amount of post-tax income available to him/her. It is important to understand the tax implications of mutual funds before one decides to invest in them.
The taxation of mutual funds is a little complicated and detailed.
Municipal Funds Are Not Taxable: There are many mutual funds that are issued by municipalities in the US. For a US resident, the income from these funds is not taxable. Hence, if you are investing to minimize your tax liability, these funds provide a good opportunity to you.
Short-Term Tax: Mutual fund units that are sold within a year or less are subject to short-term tax at the same rate as your income tax i.e. they are added to your income. Otherwise, they are taxed as long-term capital-gain tax, where the tax rate is considerably lower. Hence, it is important to ensure that your mutual fund does not give dividends too often.
Re-Investment Tax: In case, an investor does not withdraw his/her money from a mutual fund then the amount re-invested is subject to tax. However, this tax adds up to the cost of investment. Hence, when you finally sell the units, you have to ensure that you add tax costs. For example:
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