Hidden fees and expenses are one of the many things investors are often unaware of when investing in mutual funds. The tax implications that come from mutual fund investing are another aspect that sometimes goes unexplained. The tax liabilities associated with investing in a mutual fund can be significant. It’s important to know how these investments are taxed in order to avoid any surprises on next year’s tax bill.

When you purchase shares of a mutual fund, you are buying part of a collective investment that holds many individual investments, each with its own pre-existing tax liabilities. The way mutual funds work is that the shareholders are responsible for paying taxes on any realized net capital gains. Capital gains from a mutual fund are given back to shareholders in the form of a distribution once a year. Even if you reinvest your distribution, you still owe capital gains taxes on it, to the tune of 15 percent for all tax brackets except the top bracket, which owes 20 percent, plus a 3.8 percent Medicare tax in some circumstances.

Let’s say you own 10 shares of a mutual fund that includes stock from companies A, B and C. If the mutual fund sells their shares of company C, that creates a taxable event. The sale of company C stock resulted in net realized gains, which are given to you through a capital gains distribution at the end of the year. Even though you didn’t sell any of your own shares or make any changes to your own investment portfolio, you are responsible for paying the taxes that resulted from the mutual fund’s trade.

Another tax implication of a mutual fund is how net realized losses work. When an investor holds individual investments (not in a mutual fund) and experiences a realized loss, the investor can apply up to $3,000 of those losses towards gains and other income on their taxes per year, and carry the losses forward year after year until completely written off. With mutual funds, though, when net realized losses occur as a result of the trades within the fund, those losses cannot be written off by the shareholder. It’s only when the entire mutual fund is sold at a loss that the loss can be applied towards gains and earned income on your taxes.

When investing in mutual funds, there are a few things you can do to help lower your tax bill. One great way to avoid taxation on mutual fund distributions is to own them through an IRA, 401(k) or other tax-deferred retirement account. Investments in these accounts won’t be taxed until you withdraw from them. Also look into mutual funds that have a low turnover rate, meaning investments within the fund aren’t bought and sold a lot. This can lower realized capital gains. Finally, consider investments other than mutual funds. There are many different types of investments and some, including exchange-traded funds (ETFs), tend to be much more tax-efficient.

Evaluate the tax liabilities you incur every year through your mutual funds, and see if you might be able to save any money by making a change. When you are paying less in taxes, you can save and invest that money to help you reach your financial goals.

Christopher Scalese is a financial advisor, author of the book, “Retirement is a Marathon, Not a Sprint,” and president of Fortune Financial Group. To receive a complimentary copy of Scalese’s full report on mutual funds, call 1-800-844-0656, or for more information, visit www.fortune-financial.org. Interested in writing a guest column? Send IN THIS CORNER ideas to business@timesshamrock.com.