Whether you invest in a mutual fund or buy a CD, your investment usually generates investment income
Mutual funds are professionally managed companies that invest in securities and pass on most of their income to investors who buy shares of the fund. The Securities and Exchange Commission regulates the mutual fund industry. In October 2007, mutual funds had combined assets of about $12.36 trillion.
In the case of stocks and mutual funds, income is earned as dividends. Dividends are a distribution of profits. In the case of bonds and savings deposits, income is earned as interest. Interest is an expense that the company is paying to you.
A bond fund invests in bonds that pay interest to the fund manager. The fund manager, in turn, distributes interest to you in the form of dividends.
Interest makes up a type of investment income that is taxed as ordinary income. Dividends make up a type of investment income that is taxed at the same rate as capital gains. Ordinary income includes wages, salaries and other income that is not considered as capital-gains income.
If you earn more than $1,500 in dividends and interest with a taxable account, the Internal Revenue Service requires you to complete Schedule B of IRS Form 1040. Each institution that pays you dividends or interest is required by law to mail you a Form 1099 by Jan. 31 to help you gather the information necessary to file your income tax return.