Answers to your common tax questions.
Why do mutual funds pay capital gains?
When a mutual fund sells a holding, it receives any profit or capital gain that results from the sale. Mutual funds, by law, must pay essentially all gains to their shareholders in the form of capital gains distributions. These distributions, which typically happen once a year, are made for tax reasons.
What are capital gains and losses?
In addition to gains distributed to you from the sale of securities in a fund’s portfolio, you also may have taxable gains from selling your fund shares. If you sell your shares for more than their original cost, you may have a capital gain. If you sell them for less, you may have a capital loss. In general, any redemption or exchange of shares is considered a sale of shares.
What is the difference between short-term and long-term gains and losses?
Gains and losses on mutual fund shares held for one year or less are deemed short-term. Shares held for one year or longer are deemed long-term. Short-term capital gains are included with your other ordinary income and are taxable at your marginal tax rate. Long-term capital gains are generally taxed at a 15% tax rate.
What is cost basis?
Cost basis is typically the purchase price of your mutual fund shares, including any sales charges paid when your shares were purchased. It’s used as a benchmark to determine if you have a capital gain or capital loss when you sell or exchange your shares in the future. These gains or losses need to be reported to the Internal Revenue Service (IRS) on federal tax returns.
How is cost basis reported to the IRS?
For shares acquired after January 1, 2012, (covered shares) Principal Funds is required to track and report all gains or losses from the sale or exchange of mutual fund shares in taxable accounts. This information is provided on Form 1099-B to both you and the IRS. For shares acquired before January 1, 2012 (non-covered shares), you will be responsible for calculating and reporting your gains and losses at tax time. Principal Funds uses the Average Cost (ACST) method as the default for cost basis reporting and will continue to use that method for non-covered shares on eligible accounts. For covered shares, you can choose how you want to report your cost basis for each account you hold.
How do you elect or change your cost basis reporting method?
To assist in electing or changing the cost basis reporting method, the Cost Basis Election form form can be downloaded and completed. The form provides a brief overview of all the cost basis reporting methods available. You may also maintain your cost basis information online by logging into your account on www.principal.com. We recommend that you meet with a qualified tax professional to determine which method should be considered for your individual tax situation.
Cost basis — What is a "wash sale"?
If you sell shares at a loss and purchase shares (including reinvested dividends) in the same fund, regardless of the account, within a 61-day period, beginning 30 days before the sale and ending 30 days after the sale, the IRS considers the purchase a “wash” sale. The loss is disallowed for tax purposes and must be added to the cost basis of the repurchased shares.
Please refer to IRS Publication 550, Investment Income and Expenses, for more information on wash sales.
I did not redeem any money from my account. Why did I receive a 1099-B?
For tax purposes, exchanges are treated the same as if you had sold your shares in one fund and used the cash to purchase shares in another fund. So, the same tax rules that apply to calculating gains and losses when you redeem shares apply when you exchange them.
Are capital gains distributions paid by a tax-exempt fund treated as taxable income?
Yes. If there is a capital gains distribution, you’ll receive a 1099-DIV, which indicates the distribution as taxable income.
I have a tax-exempt fund. Do I have to report it on my state income tax?
Yes. Tax-exempt funds are exempt from federal taxes only. However, a portion of a tax-exempt dividend may be state tax exempt, depending on the state in which you reside. Refer to the state listing in the tax reporting supplement also enclosed with your 1099-DIV to see what rules apply to your state.
My dividends were less than $10, so I did not receive a 1099-DIV. How do I know how much to report?
Your year-end statement will have the amount of dividends that were paid to you throughout the year.
I did not receive a 1099-DIV. Do I still have to report my dividend income?
Yes. If you have a tax-exempt fund, the dividends are federally tax-exempt and Principal Funds doesn't report these to the IRS. However, these dividends should be reported on Form 1040. You'll also have to report them on your state tax return. Use your year-end statement to find the amount paid to you.
What do I need to do with the foreign tax paid amount on my 1099-DIV?
Some funds that invest in foreign stocks and meet certain requirements choose to pass on foreign taxes to their shareholders.
In these funds, a gross dividend is reported to each shareholder, and you’re allowed to offset that income with a credit based on foreign taxes paid by the fund. This credit is subject to limitations and can make tax reporting complex.
Contact your tax professional for questions regarding your foreign tax paid credit. You’ll receive a letter stating all foreign tax amounts of Principal Funds with your 1099-DIV.
What are ordinary and qualified dividends?
Ordinary dividends are paid out of earnings and profits from a corporation or a mutual fund and are considered ordinary income—not capital gains. These are reflected in box 1a of Form 1099-Div.
Qualified dividends are the ordinary dividends subject to the same 15% (0% for shareholders in the 10% and 15% tax brackets) maximum tax rate that applies to net capital gain. These are reflected in box 1b of Form 1099-Div.
Why did I receive a 1099-R?
You were sent a 1099-R because you received a distribution from your Principal Funds traditional, Roth, SEP, or SIMPLE IRA. This transaction is treated as a taxable event. Generally, IRA distributions are treated as taxable income for the year in which the distribution is received. You'll need to include your 1099-R with your federal and state tax returns.
I reinvested my IRA distribution into another IRA. How come I still received a 1099-R?
There are three possible reasons:
- Distributions from a traditional IRA are taxable to you unless the money is rolled over into another traditional IRA within 60 calendar days of the date you receive the money.
- If you have a Traditional IRA and request a direct rollover to another qualified account that the monies originated from, you’ll receive a 1099-R with the distribution code of “G.” This type of distribution is not taxable to you.
- If you remove an excess contribution from your IRA prior to your tax-filing deadline (including extensions), only the earnings are taxable. The distribution is reported on the 1099-R, but the earnings are the only part that’s taxed.
How do I know how much of my IRA distribution is taxable on my 1099-R if there is no amount in box 2a?
You’ll see that box 2b has been checked “Taxable amount not determined.” Tax laws permit IRAs to hold nondeductible contributions, which are made using income that has already been taxed. For IRAs funded with deductible and nondeductible contributions, special rules apply when figuring the tax on distributions. (See IRS Publication 590 for additional information.)
Why did I receive a Form 5498 and what do I do with it?
The IRS requires employer contributions to a SEP-IRA and contributions made to a SIMPLE IRA to be reported on the Form 5498 for the year they are actually deposited to the account, regardless of the tax year for which they are made.
Why doesn’t my 5498 show a prior year contribution made on my SEP/SIMPLE IRA?
Form 5498 issued by Principal Funds on behalf of SEP, and SIMPLE IRA accounts reflect the total contributions made in the calendar year regardless of tax year.
What is the alternative minimum tax (AMT)?
Alternative minimum tax is an income tax imposed by the federal government on certain individuals, corporations, estates, and trusts. Refer to Form 1040 instructions and the Form 1040A instructions on the IRS website to determine if you are subject to the AMT.