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.