A Democratic leader in the US Senate has proposed ending a major benefit of investing in exchange-traded funds, more commonly known as ETFs.
In recent years, many investors have shifted from mutual funds to ETFs because of their tax efficiency. But Senate Finance Committee Chairman Ron Wyden, D-Ore., Recently bill unveiled this, according to reports, would end this tax advantage by repealing a system that currently allows tax deferral on ETF-related capital gains.
Under the new system, investors large and small would be forced to pay ETF-related capital gains taxes much sooner. Bloomberg Reports that such a change could “potentially change the entire landscape of American funds”.
The current tax advantage of ETFs dates back to a law dating back to the Nixon administration, Bloomberg reports. It exempts regulated investment companies from the recognition of taxable gains on assets when a company pays shareholders âin kindâ.
This means that under current law, if the company pays investors who withdraw securities like stocks – rather than cash – the gains can be deferred. As Bloomberg reports:
âETFs are structured so that money flows in and out through facilitators called authorized participants, and redemptions for a fund almost always take place in-kind. This means that if there are enough withdrawals, an ETF can avoid fully recognizing taxable gains. Rather than paying a tax on a fund’s earnings each year, investors typically pay nothing until they sell their ETFs.
However, under Wyden’s new proposal, ETFs would eventually pass on capital gains to their millions of investors every year. (Wyden said this week that retirement accounts will be exempt, Bloomberg reports.)
Jeremy Senderowicz – a partner at law firm Vedder Price, which represents several ETF firms – told Bloomberg that because ETFs are transfer vehicles, any tax increases under the proposal would go directly to shareholders, “who are not all very rich”.
However, before you call your broker in a panic, be aware that some experts say the proposal is far from being passed. Ben Johnson, director of global ETF research at Morningstar, told Bloomberg:
âThe industry is going to push back hard. It’s hard for me to see this getting popular support, largely because it’s a universal benefit, so all investors, big, small, and middleman, who invest taxable money benefit from the efficiency. tax of ETFs.
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