The stock market's performance so far this year has been lackluster at best, so it was no surprise that many of the quarterly mutual fund statements that arrived in investors' mailboxes last month were lackluster as well.
But what was surprising to some investors was that after many years of holding a fund and seeing their balance rise well beyond their initial investment, they actually have, on a per-share basis, a loss.
That may not be, as Martha Stewart used to say, a good thing, but it does have potential tax benefits. For example, if you've been unhappy with a fund but have been concerned about triggering taxes if you sell, that particular fear may be unfounded.
A small but growing number of fund companies -- giants such as Vanguard and smaller fund families such as Safeco and CGM -- have started spelling out this unexpected bottom line by including in their statements the investor's average per-share cost on some or all of their funds. With a quick glance at a newspaper, investors can then see that their fund is trading at, say, $19 a share, while their statement tells them their shares cost $21 on average. A good many funds track investors' average share cost and will provide the information if asked, but many investors don't think to.
"It isn't intuitive that somehow . . . they have a loss. They don't see it that way" when the total value of their account has grown substantially over the years, said Glenn G. Kautt of the Monitor Group Inc. in Fairfax.
This seeming contradiction comes about because much or all of that growth represents income generated by capital gains and dividends earned and distributed to shareholders by the fund.
If an investor has reinvested that income in the fund to buy additional shares, as many do, he bought them at whatever price the fund shares were at when the distribution was made. If the share price has since fallen, the result can be a fund balance that is greater than the original investment, but less than the sum of the original investment and all the reinvested distributions.
If that's hard to follow, maybe an example will help:
The CGM Mutual Fund is a balanced fund whose manager, Ken Heebner, is noted for an aggressive, some would say "gunslinger," style. This fund racked up a 39.75 percent gain last year, but suffered double-digit losses in each of the three previous years.
Barry Glassman of Cassaday & Co. in McLean, using figures from the mutual fund research firm Morningstar, found that an investor who put $10,000 into CGM Mutual in May 1994 and held it 10 years -- until this past May -- would have seen his account value grow from $10,000 to $18,145.
But along the way, this investor would have received $11,931 in distributions, including big capital gains in 1997 and 1999. If he reinvested those distributions he would now have more shares and together they would have been worth $18,145 at the end of May. But because the share price was higher when the distributions occurred, he has actually paid a total of $21,931 for his entire holding. Had he sold in May (CGM has since risen a bit), he could take a tax loss of more than $3,000.
It's not clear how many fund investors are in this position. But many fund managers took large capital gains during the hot market of the late 1990s. Or they took them later to lock in gains as the market started down. In either case, if those distributions were reinvested, they likely went to buy shares at prices above current levels.
This situation, while not exactly enviable, does offer fund holders some additional flexibility in adjusting their portfolios. And while many advisers don't suggest rushing out to make tax-inspired moves at this point in the year, it's not too early to start thinking about where you stand and planning accordingly.
For example, many investors hesitate to sell a fund they are unhappy with because they think they have a gain and worry about the taxes they might face. Well, maybe there wouldn't be any. In fact, there might be a capital loss, which can be used to offset other gains or to shelter up to $3,000 of ordinary income.
Investors who need to cash in an investment -- for example, to pay college tuition -- or want to rebalance their portfolio or simply get out of a poor-performing fund can take solace from the fact that at least there won't be a tax hit. If they have real gains elsewhere, they may be able to offset them.
Funds that track your average share cost, or "basis," as the tax people say, will give it to you if you ask.
If not, you may be able to figure it yourself fairly easily, particularly if you haven't sold any of your shares along the way, Glassman said. If you have your statements -- and you should be keeping them -- "all you need to do is add up all the money" that you invested directly "and all the reinvested amounts," he said. Then divide that total by the number of shares you own to get the average price. This will give you the "single category" basis, meaning that it does not distinguish between long- and short-term gains.
If you don't have the statements, contact your broker, if you purchased through one, or the fund itself. They can often help.
If you have sold shares in the past, you'll need to look back at your tax returns to see what basis you used. There are several ways to compute gains and losses on mutual funds and you have to stick with the method you used in the past for a particular fund.
For more on figuring mutual fund taxes, look at Internal Revenue Service Publication "Mutual Fund Distributions," which you can get from the IRS or www.irs.gov.
Kautt advised waiting until about October to begin serious tax figuring -- "the market has room to maneuver" between now and the end of the year, he noted. But starting to get a clear picture of your situation now, especially when you may have to do a bit of digging, makes sense.
The IRS and the Justice Department continue to pursue high-profile tax cases, particularly those that have attracted public attention or those in which the individual has argued that he or she doesn't have to pay.
Last week, they filed suit in Sacramento seeking to collect more than $500,000 in unpaid employment taxes, penalties and interest from Walter Allen "Al" Thompson, a Redding, Calif., employer who the government says has openly refused to withhold federal taxes from his employees' wages.
According to the government, Thompson runs Cencal Aviation Products, which makes jackets, flight bags and other accessories for private pilots. Thompson has been described by the New York Times as an "advocate of the notion that American companies and their workers do not have to pay income taxes." And he appeared on the television program "60 Minutes II," asserting that wages are not taxable and that employers therefore need not withhold federal taxes from their employees' wages, the government said.
The government argues that Thompson personally owes the $500,000-plus in employment taxes, penalties and interest, and that he and his wife owe $27,721 in income taxes, penalties and interest that they have refused to pay. It is asking the court to order foreclosure on the Thompsons' residence.
Meanwhile, in Florida, the government was in court trying to stop the operators of Tax Strategies Inc., a Lehigh Acres, Fla., company, from promoting tax schemes that have allegedly defrauded the Treasury of more than $7.5 million. According to court papers, the organization helps customers set up sham charitable foundations, trusts and corporations to eliminate or reduce their taxes.
Charitable bequests totaled $21.6 billion last year, up 25 percent from 1999 in inflation-corrected dollars, according to Congress's Joint Economic Committee.