Tax Equalization in Mutual Funds
Posted: 7 Jan 2011
Date Written: December 16, 2010
By making an annual tax election, open-ended mutual funds can treat redeeming shareholders as if they have been allocated a pro-rata share of taxable gains, when in fact they have not (known as “equalization”). Equalization provides significant benefits to shareholders and funds; however it also leads to additional fund level costs. In this study, we use equalization elections to examine how managers weigh the costs and benefits of tax minimization. Overall, our results suggest both are important in the decision making process. Even though funds and investors both benefit, only ten percent of funds use equalization. Funds in larger fund families and with higher expense ratios, both proxies for the additional infrastructure necessary to calculate equalization dividends, are more likely to use equalization. Equalization is also used when its benefits are highest, such as by funds with greater redemptions and larger unrealized gains.
Keywords: tax equalization, mutual funds, tax efficiency
JEL Classification: G23, G28, M41
Suggested Citation: Suggested Citation