Do you pay taxes on ETFs if you don't sell them?
If you hold these investments in a tax-deferred account, you generally won't be taxed until you make a withdrawal, and the withdrawal will be taxed at your current ordinary income tax rate. If you invest in stocks and bonds via ETFs, you probably won't be in for many surprises.
Do you pay taxes on stocks you don't sell? No. Even if the value of your stocks goes up, you won't pay taxes until you sell the stock. Once you sell a stock that's gone up in value and you make a profit, you'll have to pay the capital gains tax.
What are the tax implications of an index fund if you don't sell it, but just reinvest dividends every quarter/year? If the fund is held in a taxable account, the dividends and possibly some distributed capital gains are reported as taxable income each year even if they are reinvested and nothing is withdrawn.
In many cases, you won't owe taxes on earnings until you take the money out of the account—or, depending on the type of account, ever. But for general investing accounts, taxes are due at the time you earn the money. The tax rate you pay on your investment income depends on how you earn the money.
That's because mutual funds must distribute any dividends and net realized capital gains earned on their holdings over the prior 12 months. For investors with taxable accounts, these distributions are taxable income, even if the money is reinvested in additional fund shares and they have not sold any shares.
You may be able to avoid all income taxes on dividends if your income is low enough to qualify for zero capital gains if you invest in a Roth retirement account or buy dividend stocks in a tax-advantaged education account.
These funds buy or sell very few shares each year, so most generate very little in terms of taxable capital gains, if any. But there are usually taxes due on S&P 500 funds' dividends. The exact amount of taxes varies by taxpayer, though.
Mutual fund investors pay capital gains tax on assets sold by their funds. ETFs, however, don't subject investors to the same tax policies. ETF providers offer shares "in kind," with authorized participants a buffer between investors and the providers' trading-triggered tax events.
Dividends and interest payments from ETFs are taxed similarly to income from the underlying stocks or bonds inside them. For U.S. taxpayers, this income needs to be reported on form 1099-DIV. 2 If you earn a profit by selling an ETF, they are taxed like the underlying stocks or bonds as well.
For ETFs held more than a year, you'll owe long-term capital gains taxes at a rate up to 23.8%, once you include the 3.8% Net Investment Income Tax (NIIT) on high earners. If you hold the ETF for less than a year, you'll be taxed at the ordinary income rate.
Do I pay taxes on my Vanguard account?
Yes, the holding period matters. If you've owned your investment for more than 1 year before selling at a gain, you're subject to long-term capital gains tax rates. If you've owned your investment for one year or less before selling at a gain, you're taxed at short-term capital gains rates.
The act of opening a brokerage account doesn't mean you'll be on the hook for any additional taxes. But brokerage accounts are also called taxable accounts, because investment income within a brokerage account is subject to capital gains taxes.
If the value of your investments drops too far, you might struggle to repay the money you owe the brokerage. Should your account be sent to collections, it could damage your credit score. You can avoid this risk by opening a cash account, which doesn't involve borrowing money.
From the perspective of the IRS, the tax treatment of ETFs and mutual funds are the same. Both are subject to capital gains tax and taxation of dividend income.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
The IRS has the authority to impose fines and penalties for your negligence, and they often do. If they can demonstrate that the act was intentional, fraudulent, or designed to evade payment of rightful taxes, they can seek criminal prosecution.
The profits you make from selling an exchange-traded fund (ETF) are taxable, just like the profits from selling a stock or withdrawing money from a mutual fund. If you receive dividends from an ETF, they are taxable as well.
This means right now, the law doesn't allow for any exemptions based on your age. Whether you're 65 or 95, seniors must pay capital gains tax where it's due. This can be on the sale of real estate or other investments that have increased in value over their original purchase price, which is known as the 'tax basis'.
The easiest way to lower capital gains taxes is to simply hold taxable assets for one year or longer to benefit from the long-term capital gains tax rate.
Stock splits don't create a taxable event; you merely receive more stock evidencing the same ownership interest in the corporation that issued the stock. You don't report income until you sell the stock.
What is the 30 day rule on ETFs?
If you buy substantially identical security within 30 days before or after a sale at a loss, you are subject to the wash sale rule. This prevents you from claiming the loss at this time.
Market risk
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.
Rather than creating or redeeming shares through cash transactions made directly with fund investors and the underlying markets, ETFs are engaged in a separate circuit of share creation and redemption—a process of in-kind transactions that isn't considered to be a taxable event.
A lack of trading activity means the sale is made below the value it would have in a volatile market. Investors can choose to hold their ETFs for a return in action. Nonetheless, a decline in liquidity can mean a drop in value for both the short and long term, which makes investors more likely to sell.
