Taking Measure Of Cap-Gains Tax Changes

November 30, 2012

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Before worrying about upcoming changes to the tax code, ETF investors should first know what they pay now.

It’s getting close to the end of the year and, more so than usual, capital gains taxes are at the forefront of many ETF investors’ minds.

That’s because the Bush tax cuts, which reduced the maximum short-term capital gains rates to 35 percent and the maximum long-term capital gains rates—and qualified dividend rates—down to the current beneficial 15 percent rate, are set to expire at the end of the year.

If those tax cuts are allowed to expire without an extension, barring any new rates being implemented, long-term rates are set to go back up to 20 percent, and dividends and maximum short-term rates are scheduled to rise as high as 39.6 percent.

Then there’s the additional Medicare surcharge tax that’s set to go into effect on Jan. 1, 2013. This would add 3.8 percent to that 20 percent long-term rate for a total long-term rate of 23.8 percent and a maximum dividend rate of 43.4 percent for singles making $200,000 or more per year, and for married couples making a combined $250,000 or more.

Whether the current rates will be extended, or whether any new rates will apply only to those in higher tax brackets, is still unknown. Nor do we know the full details of what the tax rates will be exactly.

Hopefully, we’ll know soon.

In the meantime, what we do know is that the rates that are effective until the end of the year can be somewhat confusing as is, depending on the asset class of the ETF you own. So while we all wait for the outcome of the current discussions in Washington, D.C., it’s good to know where we stand currently.

Equity and fixed-income funds are straightforward—as most investors know already. Any capital gains made from selling the ETF held longer than a year are long term and are taxed at 15 percent. Short-term gains are taxed as ordinary income at a maximum rate of 35 percent.

Commodity and currency funds get a bit messier.

Commodities Pools

Currency and commodity funds that hold futures contracts, structured as commodities pools, are classified as limited partnerships for tax purposes. Here are a few things to remember about these types of funds:

  • They are marked to market at year-end, meaning whether or not you sold the fund, you are responsible to pay taxes on gains for that year. The fund’s cost basis gets readjusted.
  • Tax reporting is on a K-1 form instead of a 1099 that most investors are accustomed to. Some K-1's are mailed out to clients as late as March.
  • Gains are taxed like futures contracts: 60 percent of all capital gains are taxed at the long-term rate of 15 percent, and 40 percent of gains are taxed as short term at a maximum rate of 35 percent, regardless of holding period. That comes to a blended, maximum rate of 23 percent.



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