Mutual fund gains are taxed in many different ways.

Each year, mutual funds pay out or "distribute" to investors 100 percent of the dividends and interest they receive and almost all of the capital gains (net of capital losses) they realize when they sell stocks or other securities.

All of these distributions are taxable, even if they are reinvested in additional shares. Some years, a fund might make capital distributions even if its share price declined, if it sells stocks from its portfolio in which it has a profit.

If you own shares in a taxable account, you will receive a Form 1099-DIV from the fund showing the different types of distributions you received during the year:

Ordinary dividends are taxed at your ordinary income tax rate.

Qualified dividends, issued by most U.S. companies, qualify for a lower rate -- 15 or 5 percent, depending on your tax bracket.

Long-term capital gain distributions are taxed at the same rates as qualified dividends, either 15 or 5 percent, no matter how long you have held the fund.

If you sold mutual fund shares during the year, you will -- in addition to the above -- incur your own capital gain or loss. The fund will report your sale proceeds, but you must subtract your cost basis to determine if you have capital gain or loss. Your cost basis is generally what you paid for the shares, including any purchased by reinvesting dividends and capital gains distributions. This capital gain or loss can be long- or short-term depending on how long you have held the fund. Long-term capital gains are taxed at 5 or 15 percent; short-term gains are taxed as ordinary income.

If you own shares in an IRA, 401(k) or tax-deferred account, you won’t owe any tax – on either your distributions or share sales -- until you start withdrawing money from the account. At that point, every dollar you take out will be taxed as ordinary income (unless it’s coming from a Roth IRA).

For more information, go to www.irs.gov and search for Publication 564, Mutual Fund Distributions.