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The Complete Guide To ETF Taxation
November 03, 2011
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Page 1 of 6
Investors spend hours researching funds for expense ratios and spreads, trying to save a few basis points here and there. But often, not enough time is spent researching a fund’s structure and the associated tax implications. When shares are eventually sold for a gain, the different tax implications can translate into hundreds or even thousands of basis points. Investor confusion over tax treatments comes from many sources. Partly, it’s because ETF taxation is complicated. Partly, it’s because taxes are boring. And partly, it’s because ETF issuers provide unclear tax guidance in many prospectuses. Whatever the reason, we at IndexUniverse think investors deserve better, so we prepared this document to provide complete guidance on how different ETFs are treated by the tax man. WHAT DRIVES ETF TAXATION An ETF’s taxation is ultimately driven by its underlying holdings. Since funds are structured differently according to how they gain exposure to the underlying asset, an exchange-traded product’s tax treatment inherently depends on both the asset class it covers and its particular structure. A fund’s asset class can be classified in one of five categories: equities, fixed income, commodities, currencies and alternatives. For tax purposes, exchange-traded products come in one of five structures: open-end funds, unit investment trusts (UITs), grantor trusts, limited partnerships (LPs) and exchange-traded notes (ETNs). Many commodity and currency funds that hold futures contracts are regulated by the Commodity Futures Trading Commission (CFTC) as commodities pools, but they’re classified as limited partnerships for tax purposes by the IRS. Therefore, “limited partnership” will be used to refer to the structure of these funds throughout this paper. This five-by-five matrix—five asset classes and five fund structures—defines all the potential tax treatments available in the ETF space. In this paper, we’ll use asset class as the primary sort, as that is the easiest way to classify and think about funds. Note: The tax rates we’re about to discuss are relevant through the end of 2012. Starting 2013, tax rates are scheduled to change. Long-term gains apply to positions held for longer than one year; short-term gains apply to positions held for one year or less. EQUITY AND FIXED-INCOME FUNDS Equity and fixed-income ETFs currently operate in four different structures: open-end funds, UITs, grantor trusts or ETNs.
Examples of open-end funds include the Vanguard MSCI Emerging Markets ETF (VWO) and iShares Barclays TIPS Bond Fund (TIP). An example of a UIT is the SPDR S&P 500 ETF (SPY). HOLDRS are the only grantor trusts in the equity space, while the iPath MSCI India Index ETN (INP) is an example of an equity ETN. Fortunately, all four receive the same tax treatment: The long-term capital gains rate is 15% if shares are held for more than one year; if shares are held for one year or less, gains are taxed as ordinary income—with a maximum rate of 35%.
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May 18, 2012
Facebook's Effect On Tech ETFs Facebook’s IPO is the news of the day. What does it means for ETF investors? -
May 18, 2012
SSgA 12b-1 Tempest In Teapot Rick Ferri got the world of ETFs all worked up this week about possible 12b-1 fees. Luckily, it looks like he sounded a false alarm.
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May 09, 2012 7:27 am
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JP Morgan & ETN Credit Risk
Paul & Ugo discuss the implications of J.P. Morgan's $2 billion loss, the European debt crisis and what it means for ETN investors.
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