Wednesday, October 17, 2012

Same Thing Only Different

Just finished a morning tutoring session and noticed that the client had some trouble recognizing when a different question was asking the same thing as a previous question he had already nailed. Most people get this first question wrong, but today's tutoring client nailed it in about 10 seconds:

An investor purchased shares of a growth & income fund in early February this year.  In late December this year, she receives a capital gains distribution from the fund.  Therefore
a.this represents a tax-free return of capital
b.the capital gain is tax-exempt to the investor
c.the capital gain is treated as a short-term capital gain
d.the capital gain is taxable at long-term capital gains rates

So, since he nailed that one, I assumed he'd also get this one right:

Which of the following represents an accurate statement concerning the tax implications of mutual fund investing?
a.municipal bond mutual funds distribute tax-free long-term capital gains gains distributions are determined by the fund's holding period, even if the investor has held the shares for less than one year
c.because the mutual fund provides a 1099 form, the investor is relieved of the responsibility to report dividend income to the IRS
d. all dividends distributed are currently taxed at a maximum of 15%

Notice how answer choice b is explaining exactly why the client got the first question correct? In the first question, the cap gains distribution was long-term because it was based on the fund's holding period--not the investor's. Why then didn't answer choice b scream out to the candidate?
Not sure. He knew answer a was wrong. He knew C was BS. But, still, he couldn't choose answer b here.
Maybe he was tired. But, at the testing center I'm hoping he will keep struggling with a question until he sees it in its proper light. For a lot of you, that isn't happening yet because you're only spending 15 seconds on a question. You want to know the answer without figuring out the question. That doesn't work, people. Be willing to figure out the questions, and you will end up getting licensed. HelpWithSeries65Exam


  1. the client passed his Series 6 this morning . . . 72% . . . after 6 2-hour tutoring sessions.

  2. in the first question, how did we know the fund's holding period was long term? Because it was a growth and income fund?
    thanks - and congrats to your client!

  3. Believe it or not, we just ASSUME all capital gains distributions from mutual funds are of long-term capital gains. Could they distribute a short-term capital gain? Yes, but it's a rarity--the assumption is that it's a long-term capital gain unless stated otherwise.

  4. at the top, it says: Capital Gain Distributions

    Capital gain distributions (also called capital gain dividends) are paid to you or credited to your account by mutual funds (or other regulated investment companies) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV you receive from the mutual fund or REIT.

    Report capital gain distributions as long-term capital gains, regardless of how long you owned your shares in the mutual fund or REIT. See Capital gain distributions under How To Report Dividend Income, later in this chapter.