Closed-end funds pay distributions. A closed-end fund’s market price is particularly sensitive to its ability to provide steady distributions to its shareholders. A shareholder may choose to automatically invest income and capital gains distributions issued by the fund in new shares. Or distributions may be paid in cash. By reinvesting distributions rather than taking them in cash, the shareholder is able to compound the return as invested capital.
An investment company must make distributions of ordinary taxable income (dividends and interest received, net of expenses, and realized short-term gains) and net realized long-term capital gains in order to qualify for favorable tax treatment under the Internal Revenue Code. That is, like mutual funds, closed-end funds do not pay income taxes on amounts distributed to investors. Thus, an investment company will generally distribute substantially all of its ordinary taxable income and net realized long-term capital gains each year. As a regulated investment company, a closed-end fund can pass through to shareholders tax benefits associated with the underlying investments, such as qualified dividends subject to favorable tax rates, long-term capital gains, and tax-exempt interest.
