Didn’t Buy or Sell Any Stocks This Year? Here’s Why You Might Still Face a Big Tax Bill

You didn’t sell a single stock or fund last year, but when you’re doing your returns, your tax platform shows you’re suddenly deep in the red? The reason could be your brokerage statement. Even without hitting the “sell” button all year, you could be due for major tax bills from dividends paid by individual stocks, interest from bonds, or distributions from mutual funds and exchange-traded funds (ETFs).

This “phantom income” might give you real tax headaches, even if you’re a buy-and-hold investor. The most frustrating scenario is when your investment actually lost value over the year, but still triggered a tax bill because the fund manager sold positions at a profit. Understanding these hidden triggers can help prevent surprises and help you choose investments to avoid future tax hits.

What Causes These Surprise Tax Bills?

When you own shares in mutual funds and ETFs, you’re essentially buying shares in the fund’s tax obligations. These investments must distribute dividends and capital gains to shareholders annually, creating taxable events even if you reinvest them. While both mutual funds and ETFs are structured this way, ETFs typically have fewer taxable capital gain distributions.

Here’s where you might be getting phantom income that’s boosting your tax bill:

• Trading by fund managers that creates distributed gains.
• Dividends from stocks and funds.
• Interest income from bonds and bond funds

Strategies To Help Prevent Future Tax Surprises

Here are some steps to help avoid an unexpected tax hit next time:

• Be strategic with tax-sheltered accounts: Place tax-inefficient investments (actively managed funds, high-dividend stocks, bonds) in IRAs, 401(k)s, or health savings accounts to shield distributions from taxable events. Save taxable accounts for more tax-efficient investments like ETFs and growth stocks.
• Time your investments: Check fund distribution announcements (typically October to November) before making year-end investments. Waiting until January could save you from paying taxes on gains you didn’t benefit from.
• Offset gains with losses: Consider tax-loss harvesting to counteract capital gains distributions. Be careful of wash sale rules to prevent you from rebuying similar securities within 30 days.
• Research before investing: Check a fund’s distribution history and consider passive funds over actively managed ones for better tax efficiency.

But What About This Year’s Bill?

If you’re already staring at a big tax bill, you don’t have a ton of options:

• Maximize retirement contributions: Contribute to IRAs or 401(k)s before the tax filing deadline to cut overall taxable income.
• Consider payment options: If your tax bill is larger than expected, the IRS offers installment plans. If you have a lot of phantom income to deal with, consult a tax professional about estimated tax payments for next year.

The Bottom Line

Understanding how phantom income gets onto your IRS returns is crucial for smart tax planning. Strategically placing investments in certain accounts—keeping tax-inefficient funds in IRAs and 401(k)s while using ETFs and index funds in taxable accounts—can help you avoid surprises at tax time. While you can’t eliminate investment taxes, looking ahead when selecting funds and reviewing distribution dates puts you more in control.