By Jarred Cummans
ETFs have become so popular in recent years in part because of the tax efficiencies that they offer relative to traditional mutual funds. Due to the nuances of the creation/redemption mechanism, ETFs are generally able to give investors more control over their tax situation – instead of pinning them with capital gains obligations due to the activities of other investors.
Unfortunately, however, the tax treatment of exchange-traded products cannot be summed up simply as being more efficient than mutual funds. There are various complexities across the different product structures that impact the effective tax liabilities that will be incurred on gains. And there are also some nuances that impact how taxes on various ETP positions must be reported that are of major importance to some financial advisors. Gains and losses on the majority of exchange-traded products are reported on Form 1099, just like individual stocks. A select few among a universe of 1,400+ funds, however, issue a K-1 to investors that outlines their individual share in the profits and losses of what is technically a limited partnership.
As a general rule, gains and losses for a typical ETP are reported on Form 1099, but there are a number of ETPs that are structured as partnerships and as such, will issue a K-1. Exchange traded funds that utilize futures contracts, a trait that most often describes commodity ETPs, will send out K-1s. [see also The Ten Commandments of Commodity Investing]
What is a K-1?
There is a fair amount of confusion over what exactly a K-1 is and what receiving one of these statements means. A K-1 is a tax document used to report share of profits and losses from interests in limited partnerships. These documents become relevant because many exchange-traded products are technically structured as partnerships, meaning that investors are actually limited partners. Partnerships are typically not required to pay taxes directly, instead they pass those obligations to individual partners. They do that by sending a K-1 to partners each year detailing their interest in the operations of the partnership [see also Analyzing Five High Yielding Oil & Gas Pipeline Stocks].
Many investors wish to avoid K-1s primarily because of the inconvenience caused. Schedule K-1 tends to be one of the last documents provided to taxpayers, potentially delaying the timing of their filings. For advisors with hundreds of clients, the administrative burden associated with K-1s can be less-than-optimal. But it should also be noted that receipt of a K-1 generally means a taxable event – even if the related position has not been liquidated. In other words, securities that issue a K-1 may require investors to report and pay taxes on gains annually, even if the security has not been sold.
For some, K-1s are not a significant issue – simply a minor inconvenience. Others try to avoid these schedules at all costs, preferring to use exchange-traded products that can be reported on a Form 1099. Commodity ETPs make up the majority of the K-1 issuing space, as many of these products are structured as partnerships that utilize futures contracts to offer exposure. It should be noted that physically-backed ETPs such as GLD do not issue K-1s, nor do commodity ETNs. The following table is a list of all commodity ETPs that issue a K-1 [see also 12 High-Yielding Commodities For 2012].
Ticker ETF Expense Ratio AGQ Ultra Silver 0.95% BNO United States Brent Oil Fund 0.75% BNPC STREAM S&P Dynamic Roll Global Commodities Fund 0.65% BOIL Ultra DJ-UBS Natural Gas 0.95% CANE Sugar Fund 1.00% CMD UltraShort DJ-UBS Commodity 0.95% CORN Corn Fund 1.42% CPER United States Copper Index Fund 0.95% CRUD WTI Crude Oil Fund 1.54% DBA DB Agriculture Fund 0.75% DBB DB Base Metals Fund 0.75% DBC DB Commodity Index Tracking Fund 0.75% DBE DB Energy Fund 0.75% DBO DB Oil Fund 0.75% DBP DB Precious Metals Fund 0.75% DBS DB Silver Fund 0.50% DGL DB Gold Fund 0.50% DNO United States Short Oil Fund 0.60% FOL 2x Oil Bull/S&P 500 Bear 0.75% FSG 2x Gold Bull/S&P 500 Bear 0.75% GCC Continuous Commodity Index Fund 0.85% GLL UltraShort Gold 0.95% GSG GSCI Commodity-Indexed Trust Fund 0.75% KOLD UltraShort DJ-UBS Natural Gas 0.95% NAGS Natural Gas Fund 1.50% SCO UltraShort DJ-UBS Crude Oil 0.95% SOYB Soybean Fund 1.00% TAGS Agricultural Fund 0.32% UCD Ultra DJ-UBS Commodity 0.95% UCO Ultra DJ-UBS Crude Oil 0.95% UGA United States Gasoline Fund LP 0.60% UGL Ultra Gold 0.95% UHN United States Heating Oil Fund LP 0.60% UNG United States Natural Gas Fund LP 0.60% UNL United States 12 Month Natural Gas Fund 0.75% USAG United States Agriculture Index Fund 0.80% USCI United States Commodity Index Fund 0.95% USL United States 12 Month Oil 0.60% USMI United States Metals Index Fund 0.70% USO United States Oil Fund 0.45% WEAT Wheat Fund 1.00% ZSL UltraShort Silver 0.95%
Disclosure: No positions at time of writing.
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