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As others have already said, mutual funds may make up to 3 annual distributions - long term capital gains, short term capital gains, and dividends. Each receives a different tax treatment - for example short term gains are taxed at your marginal rate (which is the highest of all the rates assuming you have any income) while long terms gains get taxed at 15% (or 5% if you meet certain income requirements).
For funds in a retirement account (IRA or 401K), you don't have to worry - the investment grows tax free. For a normal account, you have to pay taxes - therefore, when choosing an mutual fund, you want ones that have a low turnover which (usually) corresponds to low distributions and have a low tax burden. Tax consequences are often overlooked when choosing funds, but they can have a significant effect on the long term performance.
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