Close Close
ThinkAdvisor

Financial Planning > Tax Planning > Tax Reform

Debate: Should Congress End ETFs’ Preferential Tax Treatment?

X
Your article was successfully shared with the contacts you provided.

Over the past few years, Democrats in Congress have proposed several pieces of legislation that would end the tax preferences afforded to exchange-traded funds (ETFs).

Under the current ETF rules, ETF managers can sell positions by using “in-kind transactions” without triggering capital gains tax liability. The rule essentially allows the ETF manager to swap underlying holdings without subjecting the ETF investors to capital gains tax liability. The most recent set of proposals would generally eliminate the nonrecognition rule for in-kind transactions.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about recent proposals to end the tax preferences granted to ETFs.

Below is a summary of the debate that ensued between the two professors.

Their Votes:

Bloink

Byrnes

Their Reasons:

Bloink: ETFs are a complex investment structure that allow taxpayers to avoid capital gains tax liability indefinitely if they’re paid “in kind.” This tax treatment provides a huge tax loophole for wealthy investors looking to avoid paying their fair share of taxes. These are complex investment options that overwhelmingly benefit the highest-net-worth Americans out there.

Byrnes: The benefits afforded to ETFs are available across the board to every single investor. This isn’t some obscure investment vehicle that benefits only the wealthy. Taxpayers don’t have to obtain accredited investor status to participate in the investment option, and many ordinary Americans can and do invest in ETFs. ETFs are widely available pass-through vehicles. That means that every bit of the increased tax liability for an ETF is directly passed to the ETF investors and changing the tax structure here isn’t called for. 

____

Bloink: Sure, ordinary taxpayers have the option to invest in ETFs and participate in gains, but the tax benefits of investing in ETFs don’t tend to trickle down to those taxpayers. We’re talking about ordinary Americans, meaning investors that are also subject to low — in some cases, even 0% — long-term capital gains tax rates. Eliminating the tax preferences wouldn’t hurt the ordinary Americans who elect to make an ETF investment.

Byrnes: All this proposal would do is eliminate a valuable and popular tax-preferred investment strategy that benefits all taxpayers who elect to invest in widely available ETFs. It’ll never pass, and it is yet another partisan attempt by Democrats to make investment in our economy less attractive at a time when we need those long-term investments the most.

____

Bloink: Eliminating the ETF tax loophole would generate the kind of revenue that we need to fund our infrastructure projects, provide a long-term solution to our current inflation problem and hold wealthy taxpayers liable for their fair share. Most proposals exempt retirement account investments, which is how most ordinary Americans hold their ETF investments in the first place. The current loophole isn’t something that Congress ever intended and should be closed.

Byrnes: If we’re trying to encourage long-term investments and give people an incentive to keep their money in the markets, this type of rule is one that we want to avoid. If the proposal passes, it means that people who make long-term ETF investments are going to start generating annual tax liability every year. That’s going to discourage them from keeping their money in valuable investments that can provide powerful long-term gains. This law isn’t going to pass and is just bad policy overall.

___________________

  • Learn more with Tax Facts, the go-to resource that answers critical tax questions with the latest tax developments. Online subscribers get access to exclusive e-newsletters.
  • Discover more resources on finance and taxes on the NU Resource Center.
  • Follow Tax Facts on LinkedIn and join the conversation on financial planning and targeted tax topics.
  • Get 10% off any Tax Facts product just for being a ThinkAdvisor reader! Complete the free trial form or call 859-692-2205 to learn more or get started today.