As December draws to a close, investors are mulling over their taxable investment accounts to assess capital gains for the year. While exchange traded funds are a tax efficient vehicle, investors shouldn’t skimp on researching options as there are subtle differences in the tax code for varying structures.
First off, ETFs are generally more tax efficient, compared to mutual funds, because ETFs typically trade less as they try to passively track a benchmark and they utilize “in-kind creation and redemption” to diminish the capital gains tax burden on shareholders. [Beat the IRS With ETFs]
Stock ETF dividends and fixed-income ETF yields will be distributed to shareholders and are taxed like income from the underlying stocks or bonds through a 1099 statement, writes Michael Iachini CFA, CFP, Managing Director of ETF Research at Charles Schwab Investment Advisory, Inc.
Stock and bond ETFs are taxed at a current 23.8% maximum rate on long-term gains and ordinary, short-term maximum rates are 43.4% – as of 2013, a new Net Investment Income tax tacks on a 3.8% surtax for taxpayers with adjusted gross income surpassing a threshold limit.
Precious metals ETFs, like gold and silver, are structured as grantor trusts and are backed by the physical metal holdings. The IRS treats the investments as if the investor held the hard asset. Consequently, physical metal ETFs are taxed as collectibles with long-term gains at a maximum 31.8% tax rate and short-term gains taxed up to a 43.4% rate.