You may be on the hook for taxable income from your mutual funds even if they have plunged in value. This is one of the weird aspects of fund investing. They generate a tax liability anytime the fund sells more stocks at a gain than they sell at a loss during the year. Typically, funds manage this well, matching winners with losers for maximum tax efficiency. But scared investors have been fleeing the market en masse, forcing many funds to sell indiscriminately just to meet redemptions. In many cases they have had to sell long-held shares at a profit and have been unable to match them with losers. You'll be notified of any taxable distributions in a week or two and they may be whoppers, up to 10% of fund assets, says Jordan. You can offset this tax liability with losses from your other holdings. You can also choose to sell the fund right away and avoid the distribution. Another painful source of phantom income is debt forgiveness, as with a repossessed car or foreclosure on your home, or even an agreed upon mortgage work-out plan with your bank. The amount you owe but do not pay is treated as income for tax purposes. Push that income into next year, if you can, by making it just one more month before cutting any deals with a creditor.
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