Will A New Law Make ETF Investing Less Attractive?

A Democratic leader in the United States WAYHOME studio ShutterstockSA major benefit of investing in exchange-traded funds, or ETFs, has been proposed to be eliminated by the Senate.

Many investors have shifted away from mutual funds and toward exchange-traded funds (ETFs) in recent years due to the latter’s tax efficiency.Senator Ron Wyden, D-Oregon, is the chairman of the Senate Finance Committee.According to reports, recently unveiled draft legislation would repeal a system that currently allows for the deferral of taxes on capital gains linked to ETFs, putting an end to the tax advantage.

Investors of all sizes, large and small, would be forced to pay taxes on ETF-related capital gains much sooner under the new system.According to Bloomberg, such a change could have a significant impact on the entire U.S. economy.Sthe financial landscape

Bloomberg reports that the current ETF tax advantage can be traced back to a law passed during the Nixon administration.It exempts regulated investment companies from having to report taxable gains on assets when they pay out in-kind dividends to shareholders.

This means that gains can be deferred under current law if the company pays withdrawing investors in securities such as stocks rather than cash.According to Bloomberg,

Money flows in and out of ETFs through facilitators known as authorized participants, and fund redemptions almost always take place in-kind.This means that if an ETF receives enough withdrawals, it can completely avoid taxable gains.Rather than paying taxes on a fund’s gains every year, investors usually don’t pay anything until they sell the ETF.

According to Jeffrey Colon, a professor at Fordham University School of Law, ETFs have become big capital gains deferral machines as a result of the current law.

ETFs, on the other hand, would end up passing on capital gains to their millions of investors each year under Wyden’s new proposal.(Bloomberg reports that Wyden said this week that retirement accounts would be exempt.))

Because ETFs are pass-through vehicles, any increased tax under the proposal would flow directly to shareholders, not all of whom are filthy rich, according to Jeremy Senderowicz, a partner at law firm Vedder Price, which represents several ETF firms.

However, before you panic and call your broker, keep in mind that some experts believe the proposal has a slim chance of becoming law.Morningstar’s director of global ETF research, Ben Johnson, told Bloomberg

The industry will fight back vehemently.It’s difficult for me to see this gaining widespread support, in part because it’s a benefit that is universal, meaning that ETFs tax efficiency benefits all investors, large, small, and in between, who invest taxable money.

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