Democratic plan would close tax breaks on exchange-traded funds

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U.S. Senate Finance Committee Chairman Ron Wyden, D-Ore., Questions IRS Commissioner Charles P. Rettig during a Senate Finance Committee hearing on June 8, 2021.

Tom Williams | Swimming pool | Reuters

Senate Finance Committee Chairman Ron Wyden, D-Ore., Launched a new exchange-traded fund levy to help pay off Democrats’ $ 3.5 trillion budget.

Exchange-traded funds are a basket of assets, such as stocks or bonds, and can be bought or sold throughout the day like stocks. Although ordinary investors do not directly own the shares, a fund manager can buy or sell the underlying assets to financial institutions.

Regular investors generally avoid taxes when they own the fund, as financial institutions can swap the underlying assets for others, a so called ‘in-kind’ transaction, which does not trigger any capital gains. .

Wyden called for an end to the tax break for these in-kind transactions, according to the proposal, which could affect all investors in the US exchange-traded fund industry by $ 6.8 trillion.

The plan aims to crack down on financial institutions that circumvent capital gains taxes.

“We’re only talking about the taxable accounts of the wealthiest investors,” Wyden said in a statement, as the plan exempts ETFs in tax-deferred pension plans, such as 401 (k) plans or retirement accounts. individual.

“This particular proposal simply applies the same rules already in place for corporations to regulated investment firms, so that wealthy investors can no longer avoid any tax on their earnings,” he said.

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Fund managers use the in-kind trading strategy to get rid of appreciated assets without creating a taxable transaction.

For example, a fund manager can ask a financial institution to deposit shares, and the financial institution repurchases the assets that the fund manager wanted to sell two days later, which is called a “beating transaction.” heart “.

“Everyone uses [heartbeat trades] when there is a rebalancing, ”said Jeffrey Colon, a law professor at Fordham University who has researched the subject.

Wyden’s plan to tax in-kind transactions has already been pushed back by the exchange-traded fund industry, saying the plan could hurt small investors as they could also be subject to taxes.

Wyden’s proposal could bring in $ 200 billion over the next decade, according to preliminary estimates from the Non-partisan Joint Committee on Taxation. However, lawmakers are still debating how to fund the $ 3.5 trillion budget.

“As the Senate Democratic Caucus continues to examine the menu of tax policy that I have proposed, this set of closing loopholes will be an important part of our conversation,” Wyden said.


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