A 1099-DIV reports the taxable distribution of your share of the capital-gains that resulted from the mutual fund's internal trading plus the dividends paid by the stocks held by the mutual fund, essentially the difference between the Net Asset Value of the mutual fund and the value of the stocks still held by the mutual fund. The distribution is reinvested in additional shares and the NAV is reduced to the value of the underlying stocks, keeping your balance the same as before the distribution. This reduction in NAV is what keeps you from paying taxes again on this money when you later sell the mutual fund. However, a mutual fund that has increased in NAV since purchase still has a net embedded gain on the stocks still held by the mutual fund on which you must pay capital-gains tax when you sell the fund shares. The per-share taxable gain on the sale is the difference between the NAV at which you purchased the shares and the NAV at which you sell the shares.
If capital gains and dividend distributions were not made periodically, the NAV would never be reduced by such distributions and you would end up paying the taxes on the overall gain when you sold the shares instead of paying part of it along the way.
