You have probably received an unpleasant surprise this year when you discovered that you have a significant capital gains tax on your mutual funds.

Now the reason why it has happened this year, more than recent years is that the distributions within the funds have increased greatly. What that means is that when investor's cash in their shares, the fund must respond by selling some of its holdings so that they produce the cash that is owed to those investors. When they are sold at a profit it ends up being what is called a capital-gains distribution. A fancy way of saying you're going to get taxed for it. And last year these distributions skyrocketed, and with the market moving high this year, promises to again.

If your fund isn't in an IRA or 401(k), these distributions will be taxed as capital gains; it doesn't matter if they are reinvested or not. The consequences are that you may be hit with taxes that you aren't aware of.

This always happens when the market goes up and people sell to take the gains.

According to Morningstar the distribution of U.S. stock funds in the year 2000 were 6.77 percent of the share price of a fund. This is a huge percentage. Then with the market slowdown it dropped to almost nothing in the years following. For example the year 2003 it was only .37 percent as an average. Now it's beginning to climb again. Last year it was right at 3 percent, and this year could be worse.

The point of talking about this is first to make you aware of these things for this year so that you're not taken off guard by them; and for next year to look at a strategy that can greatly eliminate these concerns. Next post I'll show you a strategy to help overcome the large tax consequence regarding mutual fund distributions.