Non-taxable mutual fund distributions include return of capital, earnings in a qualified retirement plan, and income from municipal bond funds and tax-exempt money market funds. Capital losses may be used as tax deductions.

Return of capital is the return of a part of your original after-tax investment to you. It is money that you invested into the fund. It is not shares that have been sold, and it is not dividend income. Returns of capital are not taxed because they are not income. However, if you receive a return of capital, your cost basis is lowered on all your shares. This can result in a higher capital gain when you redeem shares.

— The ordinary earnings of qualified retirement plans are not currently taxed. To be qualified means to receive certain tax advantages. If you have a 401(k) plan, for example, the dividends that it receives are not currently included in your gross income. This is an incentive for people to save money for retirement. You will pay ordinary income taxes on all distributions from a qualified retirement plan, except in the case of qualified distributions from Roth IRAs.

Capital losses occur when you sell shares that have fallen in value to less than what you paid for them. For example, if you bought a share for $10 and later sold it for $8, you have a capital loss of $2 for that share. You are not taxed on capital losses. At present, you can deduct up to $3,000 per year in capital losses from your income. If you have a loss greater than $3,000, you may carry the excess over to future years until the loss is depleted.

The income from municipal bond funds and tax-free money market funds is not subject to federal taxes. This is because the securities these funds hold are not taxable on the federal level. Many of them are not subject to state taxes, either.