How are mutual funds taxed under the Excess Distribution Method ?

In the previous article (click here), we saw the basics of mutual fund taxation. In this article we understand the taxation as per the Excess Distribution Method.

When are you taxed as per the Excess Distribution Method?

Excess Distribution Method is a default method of taxation. This means that unless you have elected to follow the mark to market or the qualified electing fund regime, you will be taxed as per the Excess Distribution Method.

How does the Excess Distribution Method work?

As per the Excess Distribution Method, in the case of an actual sale or a deemed sale of a mutual fund, the gains are distributed equally over the period of holding. These gains are then subject to the highest marginal rate of taxation.  Let me explain this with the help of an example.

Say for e.g. you bought a mutual fund in the year 2010 for $100. You sold it in 2019 for $200. So you made a gain of $100.

Thus, as you can see from the table above, the total tax payable on a gain of $ 100 is $ 36.5. Now add to this the interest which the IRS has lost for all these years. So, on a tax payable of $ 3.5 in 2010, you will have to calculate the interest for 10 years. On $ 3.5 payable in 2011, the interest will have to be calculated of 9 years and so on and so forth. If you add up the total tax and interest payable, on a gain of $ 100, the total tax and interest payable can add up to more than 50% of your gains.