Funds take heavy tax hit, says study

Investors in taxable mutual funds paid 56% more in taxes on their fund holdings in 2006 than they did in 2005, according to a report released today by Lipper Inc. Mutual fund investors paid $23.8 billion in taxes last year even without selling their funds, according to the 141-page report, “Taxes in the Mutual Fund Industry—2007: Assessing the Impact of Taxes on Shareholders’ Returns,” issued by the mutual fund research firm in Denver. Fueled by changes in the tax law reducing taxes on dividends, mutual funds distributed a record $418.5 billion last year, up 57% from $266.5 billion 2005, said Tom Roseen, senior research analyst. The previous mutual fund distribution record was $376.7 billion in 2000, he said. That, in turn, led to the increase in the amount of income taxes paid by investors in taxable mutual funds, which make up about half of the $10 trillion mutual fund market, according to the report. “Taxable mutual funds are really being held to a double standard,” said Mr. Roseen, since investors in stocks do not have to pay income taxes on their gains until they sell their holdings. The Investment Company Institute in Washington has long called for changes in the tax law to allow mutual fund investors to delay paying taxes on their holdings until they sell their shares. The tax “drag” on taxable fixed-income fund performance was two to three times that of the expense ratio, while the tax drag on equity funds has lessened, according to the report. Tax-managed funds kept more of their pre-tax wealth than mutual funds that were not managed for tax efficiency, the report said.