ETFs During the Tax Season: What to Expect
April 7th 2012 at 6:00am by Tom Lydon
The exchange traded fund product is lauded for its low cost and tax efficiency. However, as ETF products now cover a wide range of asset classes, various funds may come with different tax consequences, compared to traditional passively indexed ETFs.
Traditional stock ETFs are more tax efficient than their mutual fund counterparts since they do not distribute a lot of capital gains, which may be attributed to lower portfolio turnovers and the ability to create/redeem ETF shares in “in-kind” transactions, writes Michael Iachini, CFA, CFP, Managing Director of ETF Research at Charles Schwab Investment Advisory. [How ETFs Save on Fees and Taxes]
Index ETFs. Regular stock and bond ETF profits are taxed at a 15% maximum rate on long-term gains and ordinary income rates on short-term gains of up to 35%. Dividends and interest payments are taxed just like regular income as reported on a 1099 statement. [Three Things You Need to Know About ETF Tax Efficiency]
Physically-Backed Precious Metals ETFs. Physically-backed precious metals ETFs, like those backed by gold, silver, platinum and palladium, are structured as grantor trusts, which hold physical metal bars stored in secured vaults. The Internal Revenue Service currently treat precious metals as collectibles and this treatment is extended to precious metals ETFs. Long-term gains at a collectibles tax rate can run up to 28%, and short-term gains are taxed at an ordinary income rate of up to 35%.
Futures-Backed ETFs. ETFs that trade in futures contracts are structured as limited partnerships, which means that income is reported on a Schedule K-1 form instead of the 1099 form. ETFs that hold commodity futures also fall under the 60/40 rule – gains or losses are treated as 60% long-term gains of up to a 15% maximum rate and 40% short-term gains at ordinary income rates of up to 35%, regardless of how long the ETFs are held. Additionally, the ETFs must “mark to market” all outstanding futures contracts at the end of the year, pricing the contracts as if they were sold.
Currency ETFs. Currency ETFs come three forms: ETFs that are structured as open-end funds fall under the ’40 Act Funds are taxed at a 15% maximum long-term rate and a 35% maximum short-term rate. Currency ETFs structured as grantor trusts, like precious metals ETFs, will always be taxed as ordinary income with a maximum 35% rate. ETFs structured as limited partnerships will require K-1 statements and follow a 60/40 long-/short-term gains treatment.
Exchange Traded Notes. ETNs are taxed similarly as their ETF equivalents – 15% maximum long-term gains and 35% maximum short-term gains. ETNs, though, don’t distribute income or capital gains. Commodity ETNs are also taxed like stock and bond ETNs, with the normal 15% long-term and 35% short-term gains. However, the IRS taxes all currency ETNs as ordinary income at a maximum rate of 35%, regardless of how long it is held.
For more information on ETFs and taxes, visit our taxes category.
Max Chen contributed to this article.
Story updated to correct the spelling of a source’s name, Michael Iachini.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.