Unexpected Tax Bills Coming Due on Last Year's Big Gains

In the wake of last year's outsize mutual fund returns, we're starting to see those returns' tricky little friend: capital gains distributions.

Last year, the average technology fund rocketed to a 135% return, and the average for small-cap growth and mid-cap growth funds was 61.8% and 65%, respectively, according to Morningstar. Now, as fund managers sell some of the stocks that propelled those returns, they're realizing big capital gains. And if those gains outweigh any accumulated losses from stock sales, they must be passed on to shareholders. Most shareholders simply reinvest the gains in additional shares of the fund, but they're still taxable.

Recently, several funds have paid out mammoth capital gains. On Monday, the (WPJPX Quote)Warburg Pincus Japan Small Company and (WPJGX Quote)Warburg Pincus Japan Growth funds, which returned well over 250% last year, paid out titanic gains equal to 55% and 22%, respectively, of their net asset values. The net asset value, or NAV, is the value of one share of a fund.

And last Thursday, even the (SDCEX Quote)Standish Small Capitalization Tax-Sensitive Equity fund, which ostensibly tries to minimize taxable distributions, paid out a gain equal to 14.3% of its NAV -- the largest distribution on record for a "tax-sensitive" fund, according to Morningstar.

Capital gains distributions in excess of 10% to 15% of a fund's net asset value are considered large. Mutual funds typically announce capital gains distributions toward the end of their fiscal years, though Warburg Pincus and Standish decided to make their distributions early.

That should give investors pause. Buying a fund just before it makes a distribution means you are essentially paying taxes on other shareholders' profits.

It's not easy to figure out which funds might be in danger of sticking investors with a fat distribution, but we've given it a try.

We screened stock funds for those with more than 60% of their assets invested in stocks that represent either realized or unrealized gains. We also looked for funds whose turnover rate -- the percentage of the portfolio that has changed in the past year -- exceeds 100%, making it more likely that they sold their winning stocks. And to make our list, a fund's portfolio information couldn't be older than March 31.

Seventeen funds made the unenviable cut, most of them small- and mid-cap growth funds. On average, they racked up a 66.3% gain last year, and many have kept up the pace this year.

Keep in mind though, that while these funds might have a high percentage of winners, that doesn't guarantee they'll saddle shareholders with a fat tax bill. If some of their winners turn into losers, or if the fund manager strategically offsets taxable gains with taxable losses, a big tax bill could be turned into a small one, or be wiped out altogether.

Of course, if you're buying the fund in a tax-deferred account, like an Individual Retirement Account, or IRA, you have nothing to worry about.

Tax Alert High capital gains and turnover could produce taxable distributions for holders of these funds.
Fund	Capital Gains Exposure*	Turnover %	1-Year Return
(EKABX Quote)Evergreen Small Company Growth	89%	125%	61.1%
(ADSPX Quote)Pilgrim SmallCap Opportunity**	86	223	92.5
(SCFIX Quote)Seligman Capital	73	132	92.9
(PASGX Quote)Phoenix-Engemann Focus Growth	67	119	40.6
(TWNOX Quote)American Century New Opportunities**	67	156	156.6
(FACAX Quote)Fortis Advantage Capitall	64	271	99.7
(MONTX Quote)Monetta	64	108	61.6
(BESCX Quote)Berger Small Company Growth	64	128	95.2
(PTACX Quote)PIMCO Target	63	229	111.2
(WALLX Quote)Wall Street	63	166	80.1
(EKJBX Quote)Evergreen Large Company Growth	63	132	37.4
(NPMCX Quote)Navellier Aggressive Micro-Cap	63	196	60.5
(PBLDX Quote)PBHG Limited**	63	108	92.1
(PAPIX Quote)PIMCO Capital Appreciation	62	120	37.6
(WCATX Quote)Warburg Pincus Advisor Capital Appreciation	62	144	49.6
(IVEGX Quote)Ivy U.S. Emerging Growth	60	107	65.8
(WPHSX Quote)Warburg Pincus Global Health Science	60	146	44.8
Avg. U.S. Stock Fund	13	113	25.2
*Percentage of assets representing realized or unrealized gains. ** Closed to new investors. Performance figures as of Aug. 22. Portfolio data as of a fund's most recent public portfolio. Source: Morningstar.