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GTT RESOURCES: ETFs

See our Updated Trader Tax Center pages.

ETFs & ETF options: A major tax update

Our new ETF tax research and compelling arguments from Robert Green, CPA and tax attorneys Mark Feldman and Roger Lorence make this article a must-read.

The highlights:
Sales of commodities/futures ETFs are sales of securities, not a sales of a futures contract. Commodities/futures ETFs pass through portfolio income, including Section 1256 (futures) tax treatment.

We detail our arguments for using Section 1256 lower 60/40 tax rates on most options ETFs. We also explain the opposing arguments the IRS could raise and suggest special tax return footnote disclosure or obtaining a tax opinion letter.

A lot of ETF taxation content on the Internet isn't correct. Our in-depth article answers many tax questions, but not all. ETFs cover the gamut of instruments, many different structures are used and tax treatment is very confusing.

Click here to read our blog article "ETF tax and regulatory issues" dated March 23, 2011.

Overview of ETF tax treatment:

Securities ETFs: Securities ETFs are usually Registered Investment Companies (RICs). Like mutual fund RICs, securities ETFs pass through their underlying ordinary and qualifying dividends to investors. When you sell a securities ETF, it's deemed a sale of a security, calling for short-term and long-term capital gains tax treatment.

Commodities/futures ETFs: Commodities/futures ETFs may not use the RIC structure, so they are usually publicly traded partnerships (PTPs). Commodities/futures ETFs issue annual Schedule K-1s passing through their underlying Section 1256 futures tax treatment on futures transactions to investors, as well as other taxable items too.

When you sell a commodities/futures ETF, it's still deemed a sale of a security, calling for short-term and long-term capital gains tax treatment. That may be counter-intuitive, since it's a commodities/futures ETF, and the ETF itself is still considered a security for tax purposes. We elaborate on this point and ETFs in the article.

Precious metals ETFs: Physically backed precious metals ETFs may not use the RIC structure either. Although they could use the PTP structure, they usually choose the publicly traded trust (PTT) structure (also known as a grantor trust). A PTT also issues an annual Schedule K-1 passing through tax treatment to the investor, which in this case is the "collectibles" long-term capital gains tax rate on sales of physically backed precious metals (such as gold bullion).

The sale of a precious metal ETF is not a sale of a security, but rather it's deemed a direct sale of physically held precious metals applying the "collectibles" long-term capital gains tax rate. (The short term rate applies in those instances, too.)

Options on ETFs have unclear tax treatment. The IRS hasn't clearly stated tax treatment on sales of options based on ETFs. Many tax attorneys make the case that sales of exchange-listed options on broad-based securities ETFs as well as on commodities or futures ETFs should be treated as Section 1256(g)(3) non-equity options, with lower 60/40 tax rates. If you wish to take such a position, you should consider getting a tax opinion in order to protect yourself from penalties. Sales of options based on narrow-based securities ETFs are treated like securities.

If you have any questions on tax treatment for ETFs and options on ETFs, consider a consultation.