No one can escape taxes. But mutual fund investors may be able to sidestep them -- at least temporarily.

Mutual funds are required to pass along dividends and net realized capital gains to shareholders every year. Shareholders must then pay taxes on these distributions.

If you know a fund will be making a large taxable distribution shortly, or if there are telltale signs that a distribution may be in the offing, you may want to wait to buy that fund. Otherwise, you could wind up paying taxes on the gains a fund has made for other shareholders.

"You don't want to buy into a distribution if you know there's going to be one," says Bryan Olson, director at

Charles Schwab's Center for Investment Research

.

Most funds make these distributions toward the end of the year, particularly in December. So, if you're looking to put some money to work in a mutual fund, check to see if a distribution looms. You may decide that the short-term tax hit doesn't bother you if you plan to be in the fund for the long haul, but at least you won't be blindsided.

A Big Year for Distributions

"This is definitely a year to be wary," warns

Morningstar's

Russ Kinnel.

So far this year, the pace of fund distributions well exceeds last year's, with several funds having passed along enormous capital gains. For example, the

(WPJGX)

Warburg Pincus Japan Growth fund and the

(WPJPX)

Warburg Pincus Japan Small Company fund paid out giant gains. Generally, any distribution that's more than 15% of a fund's net asset value, or NAV, is considered large. These Warburg Pincus funds made distributions that were 22% and 55% of their NAVs, respectively.

And these are not isolated incidents, since it's a good bet that more will be coming.

In 1999, more than 150 funds

produced returns of 100% or higher. Now as fund managers sell some of the stocks that delivered those triple-digit returns, they are realizing big capital gains. And the realized gains that outweigh the realized losses get passed on the shareholders.

The Horse's Mouth

If you're interested in finding out if a fund plans a distribution, the first place to check is the horse's mouth. A fund will generally make only one major distribution of capital gains a year, typically, but not always, just after its fiscal year ends. Sometimes those distributions are a surprise, and sometimes the funds give notice.

If the distribution is announced, you can probably find that information on the fund company's Web site, or by calling the firm. Right now, the fund companies may not be able to get into specifics. If the company cannot tell you that a distribution is coming, it at least should be able to tell you when in the past it has handed out distributions and how large they have been.

If you can find out when the distribution is coming, you'll want to know the ever-important record date, which is used to determine who is eligible to receive the fund's next distribution. If you own the fund on the record date, you'll get the distribution.

Thankfully, some fund companies try to keep shareholders well informed about coming distributions, which is just as helpful if you're only a potential shareholder.

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The managers at the

Brandywine

funds gave shareholders specific distribution information in a recent letter.

As of mid-August, the

(BRWIX) - Get Report

Brandywine fund had realized approximately $13.75 per share of gains to be distributed to shareholders of record on Oct. 26. Of that amount, $8.20 will be taxable at the lower 20% long-term rate.

That's just an estimate, and the final number won't be available until early October. But at least Brandywine is trying to keep its investors informed.

Other fund companies will release these estimates later in the year, as the actual distribution dates approach.

Looking for Clues

If the company hasn't given any indication that a distribution is coming, there are other clues.

The biggest hint is performance. When a fund has racked up huge gains in the past year, the manager may have done some selling this year to lock in gains. That translates into distributions.

A fund that's been experiencing heavy shareholder selling during the year could also be poised to make a fat distribution. A manager might be forced to sell stock to meet these redemptions, realizing gains in the process. If you've noticed a considerable drop in a fund's assets that doesn't correspond with its performance, you might expect to see a big distribution around the holidays.

Another key sign that a distribution may be coming is when the fund's management changes hands. If new managers want to tweak the holdings to reflect their personal style, that selling often results in distributions.

If you want to know how big a coming distribution might be, that information is even tougher to find. But Morningstar calculates the

potential

capital-gains exposure in a fund, which you can find on the fund-tracking firm's

Web site. (A

recent story screened for funds that could be on the cusp of making a big distribution.)

That's helpful, but it still won't tell you the exact amount of a fund's next distribution.

The Flip Side

On the flip side, should you sell a fund if a distribution is coming? That depends on a variety of conditions, the main one being whether you plan to stay in the fund. If you do, it's worth it to take the tax hit from the distribution, which you can offset by selling a stock or other security at a loss.

Still, you may want to sell if you're less than enamored of the fund. For example, if you purchased a fund at the beginning of the year and it has lost money, you may be better off selling it to realize the loss than sitting on it and taking the taxable distribution. If you sit on it, you get the double whammy of holding a money-losing fund that is inflicting tax pain.

The long and short of it: If you're planning to buy a fund or two in the next few months, you should at least try to find out when a distribution is coming and how big it might be. Or, you can pick a fund -- such as a broad index fund or an exchange-traded fund -- that typically doesn't pass along big taxable distributions, which lets you sleep a little easier.

The alternative: paying taxes that you might have been able to avoid.

Dear Dagen aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.