7943 / How is a mutual fund shareholder taxed on undistributed capital gains?
A shareholder who is notified of an undistributed capital gain dividend includes the amount of the dividend in income in the same manner as a normal capital gain dividend (see Q 7938). However, the shareholder is also credited with having paid his or her share of the tax paid by the mutual fund on the undistributed amount; thus, on the shareholder’s income tax return, the shareholder is treated as though he or she has made an advance payment of tax equal to 21 percent of the amount of the undistributed dividend reported. The shareholder reports the undistributed dividend and is credited with the payment of tax for the calendar year that includes the last day of the mutual fund’s taxable year during which the dividend was declared.2
Generally, a shareholder who reports an undistributed capital gain dividend increases the tax basis in his or her shares of the mutual fund by the difference between the amount of the undistributed capital gain dividend and the tax deemed paid by the shareholder in respect of such shares.3
See Q 702 for the treatment of capital gains and losses.
1. IRC §§ 1201(a); 852(b)(3)(A).