Because exchange traded funds (ETFs) offer a dynamic product that can serve as a buy-and-hold or buy-and-sell investment, they can offer investors the opportunity to reap long-term or short-term gains. Knowing the difference between the two is crucial, especially when it comes time for taxes.
When investors sell an asset for or a profit, the Internal Revenue Service (IRS) denotes this as a capital gain and vice versa for a loss. Investors should be cognizant of both because taxes are owed on a capital gain and income could be offset with a loss.
For capital gains, there’s more discernment to determine the tax owed: whether the gain was short- or long-term. This is due to the various tax rates applied to short-term gains versus long-term gains, which also involves other factors such as tax bracket based on income.
Quite simply, a short-term gain is a capital gain attained if an investors buys and subsequently sells the asset within a year. Conversely, a long-term capital gain is where an investor buys and then sells an asset held longer than one year.
A day trader who purchases shares of an ETF and sells it within the hour to extract a profit is an example of a short-term capital gain. An investor who buys and holds a bond ETF for three years then subsequently sells it, will be subjected to a long-term capital gain.
Know the Tax Implications of Your ETFs
As previously mentioned, one thing investors should be duly aware of are the tax implications associated with short- and long-term gains made in the market. The tax rate will depend on the investor’s tax bracket—refer to the following IRS tables to determine the short- and long-term capital gains tax rate based on income bracket and other qualifiers.
2023 LONG-TERM CAPITAL GAINS:
|FILING STATUS||0% RATE||15% RATE||20% RATE|
|Single||Up to $44,625||$44,626 – $492,300||Over $492,300|
|Married filing jointly||Up to $89,250||$89,251 – $553,850||Over $553,850|
|Married filing separately||Up to $44,625||$44,626 – $276,900||Over $276,900|
|Head of household||Up to $59,750||$59,751 – $523,050||Over $523,050|
2023 SHORT-TERM CAPITAL GAINS:
|Tax rate||Single||Head of household||Married filing jointly or qualifying widow||Married filing separately|
|10%||$0 to $11,000||$0 to $15,700||$0 to $22,000||$0 to $11,000|
|12%||$11,001 to $44,725||$15,701 to $59,850||$22,001 to $89,450||$11,001 to $44,725|
|22%||$44,726 to $95,375||$59,851 to $95,350||$89,451 to $190,750||$44,726 to $95,375|
|24%||$95,376 to $182,100||$95,351 to $182,100||$190,751 to $364,200||$95,376 to $182,100|
|32%||$182,101 to $231,250||$182,101 to $231,250||$364,201 to $462,500||$182,101 to $231,250|
|35%||$231,251 to $578,125||$231,251 to $578,100||$462,501 to $693,750||$231,251 to $346,875|
|37%||$578,126 or more||$578,101 or more||$693,751 or more||$346,876 or more|
There are certain instances that warrant nuanced tax knowledge. For example, physically backed gold ETFs can be taxed at a top rate of 28% when it comes to long-term capital gains versus the standard 20% rate — this is because ETFs backed by physical gold are treated as collectibles.
Given their complexity, any tax questions regarding ETFs should be directed to an accountant.
For more news, information, and analysis, visit the Financial Literacy Channel.