Final answer:
In mutual funds, both capital gains and dividends are taxable even if they are reinvested back into the fund. The correct option is A.
Step-by-step explanation:
In mutual funds (MF), capital gains and dividends are taxable regardless of being reinvested. Therefore, the correct answer to the student's question is A) Taxable. Whether or not the investor chooses to reinvest these earnings back into the mutual fund, they must report these earnings on their tax return and pay the appropriate taxes.
This can come as a surprise to some investors, as they may not receive the cash directly when these gains are automatically reinvested. However, the Internal Revenue Service (IRS) considers these events as taxable events.