Does the IRS consider the sale of mutual funds as income? I used post-tax earnings to purchase the funds.?

The IRS audited me for not claiming the $11,000 as income. I did make a capital gain on the 10,500 that I originally invested, but claimed that. It doesn't make any sense to me that I should claim dollars that have already been earned and taxed, a second time?

The profit is taxed, not the gross proceeds. The problem is that, if you don't report the sale, the IRS assumes the cost was $0.00.

I assume that you just received a letter from the IRS. This isn't really an "audit" though they can be scary.

Take your return for the year in question to a professional and get it fixed.

You sold an asset for $11000.
You failed to fill out a schedule D to show that the gain was $500.

The IRS sent you a cp2000 letter saying that since they don't know the basis, they considered it a short term capital gain of $11,000.

Find your records, show the $500 gain on the schedule D (get the right form for 2006) and send it in, so the tax bill will be adjusted down from what is on the cp2000.

Unless the stock was in an IRA or 401k, any gains or losses are reportable on Schedule D. That's why you got a 1099B, in an envelope saying IMPORTANT TAX INFORMATION. IRS assumes $0 basis if you don't file Sch D. So straighten yourself out and then straighten out the IRS. You're not being twice taxed. You'll have to file an amended return to fix this, unless you accept the IRS's calculations with 0 basis.

Profit on the sale of mutual funds is taxable income. Not sure just what you are saying. If you paid $10,500 initially for the fund, and sold it for $11,000, you should only have had to pay tax on the $500 gain - on your schedule D you should have showed sales price of $11K and basis of $10,500.

If you didn't show it on your schedule D, then the IRS will assess you tax on the whole $11K since they won't have the info on your basis. Or if you just showed a sale of $500 on your schedule D, it wouldn't have matched up to the $11K reported by the broker on the 1099-B so their computers wouldn't have recognized that was really the same thing since you reported it differently. If either of these situations is what happened, respond to the letter you got and explain what happened.

sale of mutual funds in a non-retirement account are taxable and should be reported on a schedule d.

capital gains in a retirement account like 401k or ira are not taxed.

I suggest you go over the paperwork from your brokerage account to verify.