December is tax season for mutual funds. Without getting into a review of IRS regulations, mutual funds are companies but are not like GE or McDonald’s. Funds aren't taxed as long as they distribute to shareholders essentially all taxable profits made during the calendar year.

There are several factors that determine whether a fund will have to pay out taxable distributions. Usually distributions are the result of the manager selling stocks at a gain with minimal offsetting sales in losers and no offsetting tax loss carryforwards.

Each December we review our own portfolio holdings for estimated year-end capital gains distributions (right around when most fund companies start publishing estimates). This information can be useful because investors may want to avoid buying a fund until after a big distribution, or in some rarer cases consider selling a fund before a big distribution.

Note that fund investors can largely ignore exchange-traded funds (ETFs) and bond funds. We will have some updates in our mid-month portfolio review as more funds release or tighten up their year-end distribution information.

Even though the market was quite hot in recent years, our funds have minimal year-end distributions planned. The reasons for the relative tax efficiency are that we tend to focus on lower turnover funds (few gains realized in any year by the fund manager) and out-of-favor funds (some with major tax-loss carryforwards on the books). We also sell hot funds, often before the gains are realized by the manager. In addition, we own many new funds, which don’t have much in the way of previous unrealized capital gains.

The only funds we own with noteworthy year-end taxable distributions are:

Vanguard U.S. Value (VUVLX) paying out around 9.2%, with about 40% of that is short-term gains.

Buffalo Mid Cap (BUFMX) paying out 6.3% but only 10% of that is short-term gains.

Wasatch Heritage Growth (WAHGX) paying out around 7.5%, though it is all long-term gains.

ICON Healthcare (ICHCX) paying out 6.9% though essentially all of it is long-term gains.

Some quick fund tax tips:

Don’t buy a fund before a big distribution because you think it is some sort of gift or free money. The fund price falls in lockstep with the distribution, so the only thing you get is a tax liability.

Don’t worry about this year-end tax issue if you own funds in tax deferred accounts like 401(k)s or IRAs. You won’t be liable for the distribution anyway.

Don’t worry about long-term capital gains distributions. As tax rates are currently ultra low for long-term capital gains, you can almost make the case for buying a fund before the distribution as a way to minimize your future capital gains liability when you sell the fund down the road at possibly higher capital gains rates (if capital gains tax rates go back to higher levels).

Don’t incur large trading costs, short-term redemption fees and short-term capital gains by selling a fund just to avoid a year end distribution by the fund. In these cases, the cure can be worse than the disease.

Don’t worry about small distributions. Keep an eye on year-end distributions over 5% of the fund price, particularly if it’s mostly short-term capital gains and really focus on 10% or higher year-end payouts.