I’m doing some writing on mutual fund vs ETFs and tax efficiency.
Most ETFs are taxed as if they were stocks bought at the buying price, sold at the selling price, and delivering dividends at whatever rate the ETF pays out. Easy enough.
Some ETFs are different: GLD is taxed as a collectible.
What about muni bond funds?? Underlying municipal bond interest is tax-free. But if it is transferred to the investor via an ETF dividend payout, does it suddenly become a taxable dividend instead of tax-free municpal interest?
This isn’t relevant for my current project, but I’m curious. A quick google search did not uncover the answer readily, so maybe one of you knows instead???
I would think that it retains it’s tax free characteristic and will be separately reported on your 1099 from the rest of your dividends, but I don’t know. I’ve never owned an ETF like that. In general, as far as taxes are concerned, the characteristic of the income/expense is retained when it passes through to the investor. Tax free stays tax free, qualified stays qualified, etc.
Slight diversion: that’s in part why K1s can be so effing long and complex. When you report a K1, you have to split off ordinary and qualified dividends, taxable and tax free interest, non-deductable portions of expenses, etc. I know all this crap from my tax accounting classes… Boring but surprisingly useful classes.
Thanks for the partial info. Certainly, if I were designing a muni bond ETF, I would think that losing the tax-free status would be a deal-killer and so would do my darndest to structure it in such a way that the ETF dividends remain tax free.
But so far I haven’t seen any documentation that that has actually happend. I guess if I dig into iShares and other ETF prospecti, I’ll find something about it buried in there, but I was just hoping it would show up in a google search on Seeking Alpha or something.
Im pretty sure they keep the same tax efficiency for a few reasons:
- Mutual Funds do- even though ETFs trade on the market it wouldnt impact the tax treatment of income
- iShares offers State Munis- they wouldnt do this if their was no tax benefit
- If their was no tax benefit the ETF would trade below NAV to increase the net of tax yield to maturity. If their were the case, abritreurs would 1) buy the munis below market price 2) have authorized particpants disesemble them for the underlying holdings and 3) sell the underlying on the market for an arbitrage
I owned NMB and NFC in 2011 and the tax treatment of divs was present on my 1099.
Income earned from an individual muni, muni bond fund, or ETF are all tax-exempt.
Cap gains on all the above are taxable.
Watch out for AMT. That’s where you’ll get dinged if you’re not paying attention.