When you buy shares in a mutual fund or exchange traded fund, you have to pay administrative and maintenance fees that form the fund's expense ratio. These fees are not tax deductible. However, fund costs do have an impact on the taxation of your investment returns and some types of fund-related fees are tax deductible.
A fund's expense ratio includes management fees that are used to cover the salary of the manager who operates the fund. The expense ratio also includes administrative fees that cover the cost of printing the fund's prospectuses and shareholder statements. Additionally, many funds charge a 12b-1 fee, which covers the cost of marketing, advertising and distribution costs and these fees are also form part of the expense ratio. You pay all of these fees on an annual basis. Many fund companies also require you to pay a broker commission known as load when you buy or sell a share. These load fees do not form part of the actual expense ratio, but like the management and administrative fees, loads are not tax deductible.
If you sell a mutual fund share within 12 months of the purchase date then you have to pay income tax on any realized earnings. You pay long-term capital gains tax on realized gains from shares that you held for more than 12 months. Calculate the taxable gains by deducting the the purchase price as well as the load fees and the expense ratio from the sale price. Therefore, while not technically tax deductible, the expense ratio counts as part of your non-taxable return of premium, which the Internal Revenue Service (IRS) refers to as your cost basis.
If you hold your shares inside a brokerage account, you may have to pay an annual account fee or advisory fees to your broker. These fees are not part of the fund's expense ratio but these costs and other types of professional fees are tax deductible. Some fund companies allow you to automatically reinvest your fund dividends in new shares within the fund. You may have to pay a fee to activate this dividend reinvestment option and such fees are also tax deductible, although these fees do not count as part of your actual expense ratio.
Tax qualified accounts are investment accounts in which your funds grow on a tax deferred basis. Retirement plans such as 401(k)s and individual retirement arrangements (IRA) are examples of tax qualified accounts and you can hold mutual fund or ETF shares inside these accounts. You cannot claim deductions for the expense ratio of a fund inside a tax qualified account but neither do you have to pay taxes on your earnings as long as you keep the money inside the account.
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