Types of Earning - Investment Companies

A mutual fund deducts it's operating expenses prior to paying the customer from the

Investment Income or Dividends on a mutual fund. ● Must know the Expense Ratio of the fund.

Regulated Investment Companies:- Funds which pay out at least [Investment Income or Dividends]

90% of the net investment income qualify as "Regulated Investment Companies under Sub Chapter M of the IRS Code. ● The investment company is exempt from paying tax on dividends that are distributed are are taxed on dividends that are not distributed.

On the ex-dividend date, the NAV [net asset value] per share of a mutual fund will: I. decrease by the amount of the dividend II. fluctuate depending on supply & demand II. be unaffected by the dividend IV. increase by the amount of the dividend.

Answer: I. decrease by the amount of the dividend. Explanation: On the morning of the ex-date, the market value of securities receiving a cash dividend will be reduced by the amount of the dividend being paid.

Question: A mutual fund sells a security for a profit that it has held in its portfolio for more than a year. It then distributes this profit to its investors. What would the tax treatment for this distribution to an investor who has owned the fund shares for 3 months? I. ordinary income II. Short term capital gain II. Tax exempt income IV. Long term capital gain

Answer: IV. Long term capital gain Explanation: The distribution of a long term capital gain (i.e. the fund held the security for more than a year) is considered a long term capital gain to the investors for tax purposes regardless of how long the investor has owned the mutual fund shares.

Which of the following is measured by a mutual fund's expense ratio? I. the mutual fund's dividend payout percentage II. the mutual fund's profitability. II. the mutual fund's stability IV. the mutual fund's operating costs.

Answer: IV. the mutual fund's operating costs. Explanation: The expense ratio of a mutual fund is used to measure the fund's operating costs or operating efficiency.

Questions: Could a fund deduct any of if operating expenses from capital gains on the portfolio?

Answer: NO. The capital gains distributions MUST be paid out 100% to the investor at least once a year.

Question: Could a sales load be charged on the reinvestment of mutual dividends?

Answer: Yes

Question: A mutual fund investor elects to reinvest a dividend rather than take it in cash. The tax consequence is: I. the dividend is taxable as ordinary income. II. the dividend will be taxable when withdrawn in cash later II. the dividend is not taxable IV. the dividend is taxable as a capital gain

Answer: the dividend is taxable as ordinary income. Explanation: Dividend distributions from a mutual fund are taxable income to the investor whether the investor takes the dividend in cash or elects to reinvest the dividend in additional shares.

Capital Gains Distributions are reinvested at the

NAV [net asset value] of the fund [if they are reinvested]. ● No sales load is charged.

Dividend Reinvestments: Dividend distributions reduce the

NAV on the ex-date. ● On the ex-date the Mkt value of a security is reduced by the amount of the dividend.

Formula for Expense Ratio is:

Operating Expenses ________________ Average Net Assets Operating Expense ÷ Avg Net Assets Operating Expense / Avg Net Assets

Generally, expense ratios are higher on mutual funds versus

UITs because there is no management fee on a UIT [fixed portfolio]. Most mutual funds are managed so there will be a management fee.

Total Return / Form 1099 / Sales Charges: Investment companies provide investors with a Form 1099

annually for tax purposes. Dividends & long-term gains are always listed separately on Form 1099 you get from a fund. Dividends are fully taxable. Capital gains distributions are treated are treated as long-term gains.

Capital Gains Distributions must be paid out 100% to the investor,

at least once a year.

You need to know what the Expense Ratio for a fund is

because you will have to inform the investor. ● if a fund has a high expense ratio, it will eat right into dividends paid to the investors. ● The higher the expense ratio the lower the dividends are going to be. ● The lower the expense ratio the higher the dividends are going to be.

Capital Gains Distributions may be taken in the form of

cash or shares.

Capital Gains Distributions are

derived from realized long term gains on the portfolio. ● appreciation in the value of the portfolio is not taxable. What would happen is that the portfolio manager would have to sell the securities at a gain and then take that gain and distribute to investor in order for investor end up with a capital gain.

Capital Gains Distributions are taxable

each year to the investor regardless of how they are taken [cash or shares].

Sales loads are not included in the

expense ratio. because the sales load is not an expense to the fund, it is an expense to the customer purchasing the fund shares.

Dividend Reinvestments: The Ex-Dividend Date for a mutual fund is always set by the

fund. ● because mutual funds issue only redeemable shares.

[Investment Income or Dividends] - Dividend Reinvestments: Reinvestment of dividends will

increase the investor's cost basis.

Expense Ratio for most funds is low

less than 1% [< 1%]. But they slowing increasing.

If you own a security for exactly 12 months [plus one day] or longer, trade date to trade date, the holding period is

long term.

Capital Gains Distributions are always

long-term to the investors, regardless of how long the shares have been held. This is because the Portfolio manager has already satisfied the holding period requirement when the shares were in the fund.

Long Term gains are taxed at a

lower tax rate than short term gains.

Total Return / Form 1099 / Sales Charges: When an RR recommends any mutual fund to a customer any sales charges & expenses to the customer

must be made clear to the customer.

Expense Ratio of a fund measures the fund's

operating efficiency or operating costs.

Investment Income or Dividends are always taxed as

ordinary income to the the investor, whether taken as cash or reinvested in additional shares.

When Capital Gains Distributions are paid to the investors, the NAV [net asset value] will be

reduced.

If you own a security for exactly 12 months or less, trade date to trade date, the holding period is

short term.

[Investment Income or Dividends] - Dividend Reinvestments: Dividend distributions which are reinvested may be reinvested at

the Public Offering Price or less depending on the fund. ● Means that if an investor decides to reinvest their dividends, it means that the reinvestment of a distribution could be charged [carry] a sales load [most do not].

Double tax situation is when money comes in to the investment company, and if they don't pay 90% of the income they get, they will have

to pay tax on everything that comes in. And then if dividends are paid out to the investors, the investors will also have to pay tax on those dividends received. The same money would be taxed twice.

As an investor you would rather have capital gains & capital losses because if you are investor have a capital gain of $500 and a capital loss of $500,

you would be able to offset the 2 and reduce your tax liability to zero [$0].

2 Types of Earnings when investing in Investment Companies

● Capital Gains Distribution ● Investment Income or Dividends

Conduit or Pipeline Theory - as long as the Investment Company is passing through to the customer at least 90% or more of net investment income and is distributed to shareholders, the fund does not pay tax on that distribution [income].

● Earnings flow in, fund deducts expenses ● It saves the double tax situation. ● Fund does not pay tax on that distribution [income].

If you have to treat something as ordinary income, there is no offset privilege.

● distributions are fully taxable at the the Investor's Tax Rate.

Investment Income or Dividends are derived from

● dividends ● interest ● & short-term gains in the portfolio.

Total Return / Form 1099 / Sales Charges: Total Return on a mutual fund considers

● the fund's dividends ● the fund's capital gains ● the fund's capital losses ● total return is considered to be the best measurement of fund's performance.