Return After Taxes shows a fund's annualized tax-adjusted and load-adjusted total return for the time period specified. Interest income, dividends and capital gains are each taxed at the highest federal tax rate prevailing. State and local taxes as well as individual-specific issues are ignored.
Note: Most interest income from municipal-bond funds is exempt from federal tax, while capital gains from municipal bond funds are taxable.
Morningstar applies the appropriate historical tax rate based on the date of the distribution and updates effective tax rates whenever there is a tax law change. The current tax rates are as follows:
35% Interest income and non-qualified dividends
15% Qualified dividends
35% Short-term capital gains
15% Long-term capital gains
Fund companies can denote whether a dividend is non-qualified or qualified. If fund companies provide us with this information, the tax-adjusted returns apply the correct rate (assuming the highest tax bracket). If fund companies neglect to denote the dividend category, we assume it is non-qualified and apply the highest regular income tax rates.
Per the SEC's guidance about this topic, all after-tax returns are also adjusted for loads and recurring fees. Therefore, these are technically "load- and tax-adjusted returns" and not simply "tax-adjusted returns." Therefore, a fund's after-tax return may be lower than its total return because of tax reasons, sales charges, or both.
There are two types of returns: Return After Taxes on Distributions and Return After Taxes on Distributions and Sale.
Return After Taxes on Distributions
These returns reflect the tax effects on shareholders of the portfolio manager's purchases and sales of portfolio securities. They assume that the investor continued to hold fund shares at the end of the time period, and, as a result, reflects the effect of taxable distributions by a fund to its shareholders but not any taxable gain or loss that would have been realized by a shareholder upon the sale of fund shares. After distributions are taxed, they are reinvested in the fund.
Return After Taxes on Distributions and Sale
These returns reflect the tax effects of a shareholder's individual decision to sell fund shares. They assume that the investor sold his or her fund shares at the end of the time period, and, as a result, reflects the effect of both taxable distributions by a fund to its shareholders and any taxable gain or loss realized by the shareholder upon the sale of fund shares.
Benefits
For investments in taxable accounts, taxes are often a big factor in the economic benefits an investor realizes. After-tax returns are thus a very useful way of comparing one fund to another. For taxable accounts, tax-efficient funds (those that make small income and capital-gains distributions) should be heavily favored over tax inefficient funds.
Note: The methodology used to calculate these returns are intended to comply with SEC regulations regarding mutual-fund after-tax returns. This includes the requirement that maximum sales loads and all recurring fees that are charged to all shareholder accounts be applied to the calculation. For more information, visit the SEC Web site.