Exchange-traded funds could lose major tax advantage under Democrats’ plan


Senator Ron Wyden, D-Ore., And Senator Elizabeth Warren, D-Mass., Speak to reporters at the U.S. Capitol on July 21, 2021.

Anna Moneymaker | Getty Images News | Getty Images

As Democrats grapple with how to pay their $ 3.5 trillion budget, a new proposal to tax exchange-traded funds has already been pushed back by the investment industry.

Senate Finance Committee Chairman Ron Wyden, D-Ore., Wants to crack down on “in-kind” transactions in ETFs, which allow financial institutions to swap underlying assets for another without generating any cash. capital gains.

This is one of the main tax advantages of ETFs over actively managed mutual funds, which distribute taxable gains to investors, often at the end of the year.

Wyden’s proposal to end tax relief for in-kind transactions could bring in $ 200 billion over the next decade, according to preliminary estimates from the Non-partisan Joint Committee on Taxation.

However, the move could have unintended consequences for the $ 6.8 trillion U.S. ETF market, including millions of small investors, according to industry opponents.

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“The Investment Company Institute opposes this proposed change in the tax treatment of in-kind redemptions because it could negatively impact more than 100 million Americans who invest in ETFs and mutual funds,” Eric Pan, President and CEO of the Investment Company Institute, said Tuesday. Tax and accounting conference 2021.

Nearly 12 million US households own ETFs, according to data from the Investment Company Institute, with a median income of $ 125,000.

These investors use ETFs to save for retirement, pay for higher education, pay a down payment for a home, and other important steps to boost financial security, he said.

Management companies have echoed these concerns.

“We would be concerned about policies that would increase costs and reduce returns for long-term investors and retirement savers,” said a spokesperson for global investment manager BlackRock.

State Street, another asset manager, opposes the proposal and has shared comments about the possible “negative impact” on investors who use ETFs to help them achieve their future goals.

We are only talking about the taxable accounts of the richest investors.

Ron Wyden

Chairman of the Senate Finance Committee

However, Wyden says the proposal aims to tax high net worth investors and businesses.

“We are only talking about the taxable accounts of the wealthiest investors,” Wyden said in a statement, as the plan does not include ETFs in tax-deferred pension plans, such as 401 (k) plans or accounts. individual retirement plans.

It’s unclear whether Wyden’s proposal will make the final cut as Democrats continue to debate how to fund their $ 3.5 trillion spending plan, and some experts say it is unlikely to be adopted.

But if the plan comes to fruition, there could be a bigger shift towards direct indexing, which owns the individual stocks of an index, said Jeffrey Colon, professor of law at Fordham University.

As the value of stocks goes up and down, financial advisers sell certain stocks at a loss to offset portfolio gains, known as the tax loss harvest, in order to achieve higher after-tax returns.

“I understand the [investment] the minimums are pretty high, ”Colon said. “But clearly, it will go down. “


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