Professor Jeffrey Colon was cited in a Think Advisor article about changes to watch out for in the U.S. ETF market.
2. Threats to the Tax Efficiency of ETFs
The ETF tax efficiency advantage could end because the more popular ETFs become, the more revenue the U.S. Treasury forfeits as a result.
Unlike mutual funds, ETFs are not required to distribute capital gains to shareholders when their securities are sold for a profit to meet redemptions or free up cash for new investments. When redeeming — and creating — shares, ETFs use in-kind transactions, which are not considered cash transactions and therefore do not result in pass-through capital gains.
Fordham University of Law Professor Jeffrey Colon has called for the repeal of Section 852 (b) (6) of the Internal Revenue Code, which allows for the tax-free distribution of capital gains in ETFs and in mutual funds. He labels the taxation of in-kind ETF redemptions “the great ETF tax swindle.”