Identification

• As a shareholder, you receive a portion of trading profits earned by the fund, and these profits are considered taxable income (not with tax-deferred accounts). Capital gains taxes are passed on to shareholders to avoid paying taxes out of fund profits.
  
  

Capital Gains

• There are two types of income distribution you may receive from mutual fund profits: capital gains and income dividends. Capital gains are the net sum of profits and losses throughout the year, resulting in net capital gains distributed to shareholders.
  
  

Income Dividends

• Income dividends are the dividends and interest produced by a fund's trading activities. You will pay federal taxes for both types of income distribution and often on the state and local level as well.
  
  

Tax Rates

• If you receive your dividends as reinvested distributions (buying additional shares in the fund), you are taxed according to your normal marginal tax rate (tax bracket). When you take cash payment for shares redeemed, you pay the capital gains tax rate, which is 15 percent as of November 2010.