When an investor sells a capital asset — such as a stock or a bond — for more than the amount paid for it, the investor makes a profit, or capital gain. For example, if a stock is bought for $100 and later sold for $120, the investor’s capital gain is $20.

When a fund sells securities at a profit, the sale also creates a capital gain. Two types of capital gains are realized by our funds — short-term and long-term. Net short-term capital gains are distributed to investors as income dividends and are taxed at ordinary income tax rates. Long-term capital gain distributions are currently taxed at a maximum rate of 20%.¹

When mutual funds sell securities, they typically realize gains or losses. If gains exceed losses, most funds distribute substantially all of their net gains to their investors before the end of the calendar year to satisfy federal excise tax rules. These distributions, which typically occur once or twice a year, are made primarily for tax reasons.

When the value of a fund holding increases, the fund has an unrealized gain until the security is sold. Once this security is sold, however, the fund realizes the gain and must pay a distribution unless the gain is offset by capital losses. Consequently, a fund’s capital gain distribution in a particular year is a result of the sale of securities that may have appreciated in value, perhaps during prior years when the fund’s returns were positive.

We are mindful about the taxes our investors pay on capital gain distributions. While taxes are an important consideration, meeting the funds’ investment objectives is our primary goal. Therefore, securities will typically be sold when it is deemed appropriate for investment reasons.

When gains from sales of securities outweigh losses, they accumulate and contribute to the rise of the net asset value (NAV) of the fund’s shares. When that gain is paid out to investors, its NAV, or share price, is reduced by the amount of the distribution.

Example: Say a fund share sells at an NAV of $10. If sales of the fund’s securities have resulted in the fund making a capital gain distribution of $2 a share during the year, $2 will be paid to investors on the fund’s payment date. The fund share price will decline to $8 on the record date as a result of the distribution.

The record date is the date when investors in a particular fund are entitled to receive a fund distribution.

No. Taking the example from above, investors still have $10 in value — $8 in the fund’s NAV, and $2 in their pockets or reinvested in the fund. And if they do automatically reinvest their capital gain distributions, it buys them additional fund shares at the new, lower price of $8. These additional shares compensate for the drop in the NAV, so the total value of their accounts doesn’t change. (Of course, if there is a decline in the market at the same time, they may still see a drop in the total value of their accounts.)

Example: Let’s say there are 100 shares in an investor’s account. At an NAV of $10 a share, the account value is $1,000. If the fund pays a capital gain distribution of $2 a share, the NAV drops to $8, and the original 100 shares are now worth $800. If capital gain distributions are reinvested, however, they will automatically buy $200 worth of shares — at $8 per share. The investor is able to add 25 shares to his or her account, which now contains 125 shares worth $8 each. That’s a total of $1,000, which was the original account value before the capital gain distribution was paid.

Capital gain distributions (shown in Box 2a of your Form 1099-DIV) are taxed as long-term capital gains. The tax rate for long-term capital gain distributions (assets held for more than 1 year) is determined by an individual’s taxable income and filing status. The applicable rates are 0%, 15%¹ and 20%.¹

Short-term capital gain distributions (assets held for 1 year or less) are subject to tax at ordinary income rates.

For state taxation, the treatment of capital gain distributions varies from state to state and may not follow the federal income tax treatment. Consult your tax advisor or your state tax authority for more information about state income tax reporting of these distributions.

Generally, withdrawals from retirement accounts and annuities are taxed at ordinary income tax rates. Thus, the lower rates on long-term capital gains do not apply to withdrawals from these accounts.

Investors are required to include these amounts on their federal and state, if applicable, income tax returns. This is true even if they reinvested their capital gain distributions or if the fund’s share price declined during the year.

Capital gain distribution amounts can be found in Historical Prices and Historical Distributions beginning with each fund’s record date.

Capital gain distributions paid by a fund should not be confused with capital gains you may realize when you sell or exchange mutual fund shares. If you sold or exchanged fund shares, your capital gain or loss depends on your cost basis for those shares.

Individuals will need Form 1040 and related schedules.

You can order IRS forms and schedules by calling (800) 829-3676, or download them from the Forms & Publications section at irs.gov.