Because exchange traded funds (ETFs) offer a dynamic product that can serve as a buy-and-hold or buy-and-sell investment, they can offer investors the opportunity to reap long-term or short-term gains. Knowing the difference between the two is crucial, especially when it comes time for taxes.
When investors sell an asset for or a profit, the Internal Revenue Service (IRS) denotes this as a capital gain and vice versa for a loss. Investors should be cognizant of both because taxes are owed on a capital gain and income could be offset with a loss.
For capital gains, there’s more discernment to determine the tax owed: whether the gain was short- or long-term. This is due to the various tax rates applied to short-term gains versus long-term gains, which also involves other factors such as tax bracket based on income.
Quite simply, a short-term gain is a capital gain attained if an investors buys and subsequently sells the asset within a year. Conversely, a long-term capital gain is where an investor buys and then sells an asset held longer than one year.
A day trader who purchases shares of an ETF and sells it within the hour to extract a profit is an example of a short-term capital gain. An investor who buys and holds a bond ETF for three years then subsequently sells it, will be subjected to a long-term capital gain.
Know the Tax Implications of Your ETFs
As previously mentioned, one thing investors should be duly aware of are the tax implications associated with short- and long-term gains made in the market. The tax rate will depend on the investor’s tax bracket—refer to the following IRS tables to determine the short- and long-term capital gains tax rate based on income bracket and other qualifiers.
| FILING STATUS | 0% RATE | 15% RATE | 20% RATE |
|---|---|---|---|
| Single | Up to $44,625 | $44,626 – $492,300 | Over $492,300 |
| Married filing jointly | Up to $89,250 | $89,251 – $553,850 | Over $553,850 |
| Married filing separately | Up to $44,625 | $44,626 – $276,900 | Over $276,900 |
| Head of household | Up to $59,750 | $59,751 – $523,050 | Over $523,050 |
| Tax rate | Single | Head of household | Married filing jointly or qualifying widow | Married filing separately |
|---|---|---|---|---|
| 10% | $0 to $11,000 | $0 to $15,700 | $0 to $22,000 | $0 to $11,000 |
| 12% | $11,001 to $44,725 | $15,701 to $59,850 | $22,001 to $89,450 | $11,001 to $44,725 |
| 22% | $44,726 to $95,375 | $59,851 to $95,350 | $89,451 to $190,750 | $44,726 to $95,375 |
| 24% | $95,376 to $182,100 | $95,351 to $182,100 | $190,751 to $364,200 | $95,376 to $182,100 |
| 32% | $182,101 to $231,250 | $182,101 to $231,250 | $364,201 to $462,500 | $182,101 to $231,250 |
| 35% | $231,251 to $578,125 | $231,251 to $578,100 | $462,501 to $693,750 | $231,251 to $346,875 |
| 37% | $578,126 or more | $578,101 or more | $693,751 or more | $346,876 or more |
There are certain instances that warrant nuanced tax knowledge. For example, physically backed gold ETFs can be taxed at a top rate of 28% when it comes to long-term capital gains versus the standard 20% rate — this is because ETFs backed by physical gold are treated as collectibles.
Given their complexity, any tax questions regarding ETFs should be directed to an accountant.
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