What Is the Mutual Fund Excise Tax on Undistributed Income?

A regulated investment company owes a 4 percent federal excise tax on any shortfall between its required annual payout and what it actually distributed to shareholders. The mutual fund excise tax on undistributed income, set by Section 4982 of the Internal Revenue Code, pushes funds to pay out almost all of their earnings each year so that shareholders, not the fund itself, carry the income tax.¹ The tax is not deductible against other federal taxes, so every dollar owed is a straight cost to the fund.²

The tax applies only to the gap. If a fund’s required distribution is $10 million and it paid $9.5 million, the 4 percent hits the $500,000 difference, for a bill of $20,000.

How Much a Fund Has to Distribute

The required distribution is the sum of two separate pools, each measured over its own window.

The first is 98 percent of ordinary income for the calendar year ending December 31. Ordinary income covers day-to-day earnings such as bond interest and portfolio dividends.¹

The second is 98.2 percent of capital gain net income for the one-year period ending October 31. This is realized gains from selling securities, less realized losses, over that twelve-month window. The earlier cutoff gives funds roughly six weeks to compute the number and get a December distribution out the door.¹ A net loss on the capital side can offset future gains but cannot reduce the ordinary-income requirement; the two pools stay separate.

Prior-Year Shortfall Carries Forward at 100 Percent

If a fund fell short in the prior calendar year, the entire undistributed amount from that year is added to the current year’s required distribution. The IRS recalculates the prior year’s thresholds at 100 percent instead of 98 and 98.2 percent and measures the gap between that recalculated figure and what was actually paid.¹ Last year’s miss gets tacked onto this year’s bill at full value, so delaying payouts gets more expensive over time.

What Counts as Distributed

The “distributed amount” is the fund’s deduction for dividends paid during the calendar year, plus any income on which the fund itself paid corporate-level tax under Section 852. If a fund retains some capital gains and pays tax on them, the taxed amount counts as if distributed.³

One trap catches funds that lean on the January spillover rule for income tax purposes. Section 855 lets a fund declare a dividend in January and treat it as paid in the prior taxable year for regular income tax.⁴ Section 4982 explicitly ignores Section 855. A January-declared spillover dividend does not count toward the distributed amount for excise tax, even if it wipes out the fund’s regular income tax liability for the prior year.¹ This mismatch between the two regimes is where most excise tax bills come from.

When the Tax Doesn’t Apply

A fund is completely exempt from the excise tax if every shareholder, throughout the entire calendar year, falls into one of these categories:

Qualified retirement trusts under Section 401(a) that are tax-exempt under Section 501(a), such as 401(k) plans and pension funds.
Insurance company segregated accounts held in connection with variable annuity or variable life insurance contracts.
Other tax-exempt entities whose ownership would not prevent the fund from qualifying for favorable variable contract diversification treatment.
Other regulated investment companies that themselves meet these ownership criteria.

Up to $250,000 in seed money invested when the fund was organized is ignored for this test.¹ The exception is all-or-nothing. A single taxable shareholder at any point in the year, beyond the seed money allowance, costs the fund the exemption for that entire calendar year.

Filing Form 8613 and Paying the Tax

Funds that owe the tax report it on IRS Form 8613, “Return of Excise Tax on Undistributed Income of Regulated Investment Companies.” The form runs through the math: ordinary income and the 98 percent threshold, capital gain net income and the 98.2 percent threshold, required distribution against actual distributed amount, and the resulting tax.⁵

The deadline is March 15 of the year following the calendar year being reported. If March 15 falls on a weekend or federal holiday, it moves to the next business day.⁵ The completed return goes to the same IRS service center that handles the fund’s income tax return. Most funds pay through the Electronic Federal Tax Payment System.⁶

A fund can get an automatic six-month extension to file by submitting Form 7004 by the March 15 deadline, pushing the filing date to September 15. The extension does not extend the payment deadline. Any estimated tax owed must still be paid by March 15.⁷

Penalties and Interest for Missing the Deadline

Missing March 15 adds two separate penalties on top of the tax itself:

Late filing: 5 percent of the unpaid tax for each month or partial month the return is overdue, capped at 25 percent. Reasonable cause can waive it.
Late payment: 0.5 percent of the unpaid tax for each month or partial month the tax remains unpaid, also capped at 25 percent. Reasonable cause can waive it.

Interest runs on unpaid tax from the due date until payment, compounded daily. For the first quarter of 2026, the IRS underpayment rate is 7 percent per year.⁸ It drops to 6 percent starting April 1, 2026.⁹ Large corporate underpayments carry higher rates: 9 percent in Q1 and 8 percent in Q2. The IRS resets the rate quarterly, so a balance sitting unpaid across quarters can see the rate change.⁵

The excise tax is not deductible, and neither are the penalties or interest layered on top. The full cost of a missed distribution target or a late filing lands directly on the fund.

1
Office of the Law Revision Counsel. 26 USC 4982 – Excise Tax on Undistributed Income of Regulated Investment Companies
2
Office of the Law Revision Counsel. 26 USC 275 – Certain Taxes
3
Office of the Law Revision Counsel. 26 USC 852 – Taxation of Regulated Investment Companies and Their Shareholders
4
Office of the Law Revision Counsel. 26 USC 855 – Dividends Paid by Regulated Investment Company After Close of Taxable Year
5
Internal Revenue Service. Instructions for Form 8613 – Return of Excise Tax on Undistributed Income of Regulated Investment Companies
6
Internal Revenue Service. EFTPS: The Electronic Federal Tax Payment System
7
eCFR. 26 CFR 55.6081-1 – Automatic Extension of Time for Filing a Return Due Under Chapter 44
8
Internal Revenue Service. Interest Rates Remain the Same for the First Quarter of 2026
9
Internal Revenue Service. Internal Revenue Bulletin 2026-8