For Tennessee's Hall income tax, dividends from stock are taxable. A person’s interest in the mutual fund is the equivalent of stock. The way the corporation, or mutual fund, earns income has no bearing on whether dividends are taxable. Under federal income tax law, the mutual fund dividends may be classified as “capital gains” if the mutual fund earned the income from the sale of investments. There is no such provision in Tennessee law. Such “capital gains” reported by the mutual fund would be taxable in Tennessee. If a shareholder sells shares of a mutual fund, the gain is not taxable for Tennessee income tax.
A return of capital is not subject to the Hall income tax. However, the taxpayer must show that shareholder’s investment was returned and their right to future earnings is reduced or eliminated. Otherwise, the return will be a distribution from earned surplus, which is taxable under state law.