On December 20, I received a large mutual fund distribution. Due to the large distribution I'm going to owe $7,000 when I file my return. Is it okay to just pay the $7,000 when I file my return?

If the $7,000 in tax is a result of a distribution not covered by prepayments of tax, either through income tax withholding or estimated tax payments, you should make an estimated tax payment by January 15th of the next year. If you wait to pay the $7,000 with your return, you may be penalized for an underpayment of estimated taxes. Even if you make an adequate payment of tax by January 15th, you may be assessed an estimated tax penalty by the IRS service center when your return is processed unless you file Form 2210, Underpayment of Estimated Tax by Individuals, Estates and Trusts . This is because estimated tax payments are normally made in four equal installments and the IRS will not know your liability occurred in the fourth quarter unless you explained when the income was received.

You may be subject to the penalty if you owe at least $1,000 in tax after subtracting your withholding and credits from your tax liability, and you did not prepay at least 90% of your current year's tax or 100% of your previous year's tax. (The latter percentage is higher for higher-income taxpayers with adjusted gross incomes from the previous year of more than $150,000.)

If you make an adequate payment by January 15th but made no earlier estimated tax payments, use Form 2210, Underpayment of Estimated Tax by Individuals, Estates and Trusts, to compute your penalty. Check the box on the front page selecting the Annualized Income Installment method, and then complete Schedule AI on page 3. When you compute the penalty on page 2 of that form using the numbers from Schedule AI, your penalty will be $0 if you made an adequate payment. Even if you did not make the January 15th payment or made an adequate payment, the annualized income method on Form 2210 may significantly reduce the estimated tax penalty.

How do I calculate the cost basis of the shares that have split and are later sold from my employee stock purchase plan?

You need to determine what your basis is in the company stock on the date of the split. The new shares assume part of your basis in the company stock on that date. You must divide the adjusted basis in the old stock by the number of shares of old and new stock. The result is your basis for each share of stock.

For example, if you owned two shares of company stock with a basis in one at $30 and the other $45, and the company declares a three for one stock split, you now have six shares of stock. Three of the shares will have a basis of $10, and three will have a basis of $15.

Because this is an Employee Stock Option Plan, you may have to report some or all of the gain on the sale of this stock as ordinary income (wages).

Would shares in mutual fund acquired through dividend reinvestment in prior years be long-term capital gains while shares acquired through dividend reinvestment in the year of sale be treated as short-term capital gains?

Any shares or fractional shares purchased and sold during the current tax year are short-term capital assets. For shares purchased in the year previous to the tax year to be considered long-term, the holding period must be more than one year.

Before a loss from one category, short or long term, can offset gain from the other category, the losses and gains from each category must be combined to arrive at a net gain or loss from that category. Then, the net gain or loss from each category is combined.

When you carry a capital loss over to the following year, it retains its character as long-term or short-term and must be first combined with the other entries in its category.

How do I determine my gain or loss on the proceeds reported on Form 1099-B from a short sale entered into last year if I have not yet bought the stock to deliver back to my broker?

In general, you cannot determine your gain or loss until you purchase the stock that you are going to deliver to close the short sale. You still need to report the gross proceeds on Schedule D so that the total of lines 3 and 10, column (d), reconciles with all of your Forms 1099-B.

Also, in columns b and c write "short sale." In column f, write "see attached statement." In the statement, explain the details of the short sale and that it is not closed. Include your name as it appears on your return and your social security number.

Do I need to pay taxes on that portion of stock I gained as a result of a split?

No, you generally do not need to pay tax on the additional shares of stock you received due to the stock split. You will need to adjust your per share cost of the stock. You overall cost basis has not changed, but your per share cost has changed.

You will have to pay taxes if you have gain when you sell the stock. Gain is the amount of the proceeds from the sale, minus sales commissions, that exceeds the adjusted basis of the stock sold.

I received a 1099-DIV showing a capital gain. Why do I have to report capital gains from my mutual funds if I never sold any shares?

A mutual fund is a regulated investment company that pools funds of investors allowing them to take advantage of a diversity of investments and professional asset management. You own shares in the fund, but the fund owns assets such as shares of stock, corporate bonds, government obligations, etc. One of the ways the fund makes money for its investors is to sell these assets at a gain. When this happens, the nature of the income is capital gain, which gets passed on to you. These are called capital gain distributions, which are distinguished on Form 1099-DIV from income that is from other profits, called ordinary dividends.

Where are mutual fund short-term capital gain distributions reported?

Capital gain distributions from a mutual fund are by definition long-term. That's why they appear only in Part II of Form 1040, Schedule D, Capital Gains and Losses. The annual statement you receive from your mutual fund may list short-term capital gains, but your Form 1099-DIV will show those amounts as ordinary dividends.

Ordinary dividends (which include the mutual fund's profits from short term capital gains) are reported on Form 1040, Schedule B, Interest & Dividend Income, or Form 1040A, Schedule 1, Interest and Ordinary Dividends, if the total is over $400. In addition, you enter the total ordinary dividends on line 9 of Form 1040 or line 9 of Form 1040A.

Refer to the line 13 instructions of Form 1040 for exceptions when you can enter capital gain distributions directly on line 13 of Form 1040 without having to file Schedule D.

My end-of-year statement from a mutual fund company showed amounts in 3 categories: (1) capital gains, (2) short-term capital gains, and (3) ordinary dividends. When my Form 1099-DIV came, the short-term capital gains were lumped in with ordinary dividends. Which is correct and where do I list the short-term capital gains?

Your Form 1099-DIV is correct, but so is your annual statement. For the purpose of reporting taxable income on your tax return, capital gain distributions are defined as long-term capital gains only. Short-term capital gains are taxed as ordinary income and are therefore treated as ordinary dividends on Form 1099-DIV.

Report the fund's short-term capital gains as part of your total ordinary dividends on line 9 of your Form 1040 or 1040A. (You may have to also report them on Form 1040, Schedule B, Interest & Dividend Income or Form 1040A, Schedule 1, Interest and Ordinary Dividends. Refer to the instructions to the schedule.)

How can I use mutual fund short-term capital gains, which are reported on Form 1099-DIV in Box 1 as "Ordinary Dividends," to help offset short-term capital losses?

You cannot. You did not sell the assets that produced this income, the mutual fund did. All income that is taxed as ordinary income flows through to you as ordinary dividends, whether the income is from interest, dividends, or the sales of short-term capital assets.

In the same manner, you report capital gain distributions as long-term capital gains on your return regardless of how long you have owned the shares in the mutual fund. This is because the asset was held and then sold by, the mutual fund, not by you.

Report your total ordinary dividends (including the short-term capital gains in your mutual fund) on Form 1040, line 9, or Form 1040A, line 9, with your other dividends, if any. You may also have to file Form 1040, Schedule B (PDF) , Interest & Dividend Income or Form 1040A, Schedule 1 (PDF), Interest and Ordinary Dividends.

How do you list gains from mutual funds on Schedule D and Form 1040 when some mutual funds list short-term capital gains separately and others lump short-term capital gains and taxable dividends together as dividends?

Only the capital gain distributions are reported on Form 1040, Schedule D (PDF), Capital Gains and Losses. They are reported in Part II as long-term capital gains. Short-term capital gains are taxed as ordinary income and are therefore treated as ordinary dividends on Form 1099-DIV. They are reported on line 9 of Form 1040 (PDF) or Form 1040A (PDF).

Because many mutual fund companies send out annual fund statements as well as Forms 1099-DIV, or "consolidated statements," some confusion has arisen regarding short-term capital gains. The purpose of Form 1099-DIV is to provide you with information to report income correctly on your tax return.

The annual report often breaks down the income from fund activity as dividends, tax-exempt dividends, short-term capital gains, long-term capital gains, returns of capital, and undistributed capital gains. Form 1099-DIV, on the other hand, will show only ordinary dividends (which includes the fund's short-term capital gains), capital gain distributions, and returns of capital (nontaxable distributions).

Mutual fund companies may combine the annual fund information with the Form 1099-DIV information into a consolidated statement. If this is what you receive, look for the part of the statement identified as the Form 1099-DIV or that contains language such as "in lieu of Form 1099-DIV."

If a mutual fund's assets earned tax-free dividends, are capital gains tax free when the fund is sold?

No. The kind of income the assets in the fund earn is tax-free. When you sell your shares in the fund, a taxable gain or deductible loss is realized on the sale. This is the true also for the sale of tax-exempt securities such as municipal bonds.