Surprising Income Tax Trap

Jun 12, 2023
Est. Read Time: 2 minutes

Here’s how it happens. Let’s assume you personally, or your 401(k) at work, invested in XYZ fund in January 2022. Today, you see that XYZ fund is down 26% since your purchase. The mutual fund company has sent you emails telling you how wonderful things are going, because other funds are down even more than XYZ. Naturally, you’re not happy with the result. However, you think, “I’m a long-term investor, and someday it will come back. Plus, the salesperson sent me a nice birthday card.” Then, something strange happens. You receive a 1099-DIV showing you made money and that you owe income tax on the earnings. But you’re thinking, “How did I make money, and why do I owe income tax?”

Here is how it works:

  • In 2019, XYZ fund bought Super-Duper company stock at $32.00 a share.
  • In January, when you (or your 401k) invested in XYZ fund, the stock of Super-Duper was at $58.00 a share.
  • Between the time you invested in XYZ fund in the third quarter of 2022, Super-Duper had declined to $41.00 per share and was heading south. (The decrease in the value of the fund’s asset, of course, reduced the net worth of your investment.)
  • Not so fast! Let’s look at this from the IRS point of view. XYZ bought the shares at $32.00 and sold them at $41.00, thus making a $9.00 per share profit.
  • Even though your investment is down 26%, XYZ fund made a $9.00 per share profit, and you will be required to pay capital gains tax on the difference between $32.00 and $41.00.

If you are ready to move away from stocks and would like to self direct your retirement funds, give us a call!


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