Friday, February 14, 2014

Jamie Sutherland, President of Xero U.S. (Interviewed) : Modern Cloud Accounting Services

Brent Leary for Small Business Trends writes: The cloud has always been about promotion, marketing, content and communication. But in order to create modern business, you also need to look at how the role the cloud can play in managing less glamorous areas just as important to a business’ success, like accounting.
Jamie Sutherland, President of cloud-base accounting service Xero US, talks about how cloud-based accounting solutions are impacting small businesses today. He shares his take on how these kinds of services can help small businesses understand their customers, and help companies make better, more efficient decisions leading to better results. Below is an edited transcript of the conversation. The full interview can be heard by clicking on the player below.
* * * * *
cloud accounting servicesSmall Business Trends: Before we jump in, can you tell us a little bit about your personal background?
Jamie Sutherland: My career in software started with Sage. I ran a division that had small business accounting and some HR tools. But it was desktop software, and I saw the writing on the wall for that software and then came across Xero.
They were looking for someone to lead up the expansion in the US, and we hit it off. I believe in the way Xero is approaching the market, solving the needs of small businesses as well as accountants. Having them be able to collaborate easily is a winning model, and that was an easy decision for me to jump on board.
Small Business Trends: So for folks that may not be familiar with what Xero is and what you guys do, can you fill us in?
Jamie Sutherland: Xero is online accounting software for small businesses. We take the premise of design and usability to the next level and have built the application from the ground up for the Web. Not only that, we focus in on making sure every single feature that we deliver to the market goes through a very rigorous process around design and ability.
It’s not just look and feel. We call it beautiful accounting software. It’s more about the workflow. Rethinking the old paradigms of desktop software and how a small business operates in today’s world, and designing features that just make sense for the modern small business.
Small Business Trends: How does a service like yours help an accountant build a modern accounting practice today?
Jamie Sutherland: We have a number of accountants in our network that have built their businesses on the back of Xero’s model, which is a really rewarding thing to see.
You can subscribe to Xero and see these online applications in a flash. Not only that, we provide a program to help you develop your business. What we are seeing is a number of partners of ours have gone from not having any clients up to over 100 in under a year. They can do that because the software is obviously easy.
Because we partner closely with accounting professionals, we list them on our website. What happens is, a small business that’s looking to get their taxes done, or some bookkeeping done, or some mechanic services, will come to our site and look up these accounting firms. I guess essentially driving them leads.
So a number of reasons are why being part of the Xero eco system is helpful to getting your accounting practice up and going.
Small Business Trends: Lets look beyond the accountants. How does a service like yours help a company who’s not an accounting based company, but still needs accounting services?
Jamie Sutherland: We focus on simplicity and ease of use. We’ve won some awards around our software being just that. We hear from small businesses time and time again that accounting can be complicated. So what we do is strip out all the accounting jargon for a small business so they understand the critical pieces of their business – which comes back to cash flow. It’s a clear line of site into what money is coming into the business and what money is going out.
Historically small businesses don’t keep their books up to date, and what we are seeing with Xero is that we make it easy to get information into the software through our partners. If you have a bank account and you authorize that bank account with Xero, back information will automatically appear inside Xero. So you eliminated that step around data entry, which is the bane of a lot of small businesses and bookkeepers.
Getting that information in on an automated basis and then keeping it up to date allows that small business or their advisers to help them make decisions in real time.
So the small business can save time and money, not only from the processing that needs to happen to get the data in and allocate it into the appropriate accounts, but you’ve got better information and insights into your account so you can make business decisions that are going to improve your business.
Small Business Trends: How has a service like yours given small businesses the ability to look at business a little differently, focus on customer engagement and less on important functionality, but functionality not core to their business?
Jamie Sutherland: We really see the Web as this open platform where connectivity and data flow should be seamless. I think that becomes the evolution of this.
So when you’ve got that ease of data flowing back, whether it’s your eCommerce engine, or accounting software, or CRM, point of sale, you’ve got not only real time information. But you’ve got the capability with a solid reporting tool to bring up information to make those decisions that can be key to your business. Many of those decisions revolve around the customer insight you get.
Small Business Trends: As an example with some of the stories you hear from your customers, how has that information impacted the way they view the business? Or the way they view customers?
Jamie Sutherland: From an accounting perspective, that visibility into the money owed to you and the money you owe – you can see where you’re spending your money throughout the month, and in real time so you can manage your cash flow.
Then looking at the payments that need to be made. And then looking at payments you were receiving, you can see who the outstanding debtors are and be able to keep up with that in real time.
I think it does come back from an accounting perspective, at least, because its a real time cash flow, and how you manage that. Money coming in is very, very visible inside Xero.
Small Business Trends: So where can people learn more about Xero and the services that you guys offer?
Jamie Sutherland: Xero.com, spelled with an X.
Posted on 10:36 AM | Categories:

Simplified Home Office Deduction / The new method for home office deduction is simpler, but is it better for you?

Laureen Miles Brunelli for About.com writes: Beginning in the 2013 tax year (filed in 2014), taxpayers who are eligible to deduct the use of their home for business (e.g. a home office deduction) can choose a simpler option for calculating that deduction. However, they are still free to continue to use the old home office deduction method. If you do use the new simplified method, it becomes more complicated to change methods in subsequent years (more on that in “depreciation” section below) but it is still possible.  
The new method doesn’t change the basic criteria for deducting a home office (such as a home office deduction can't be taken if it would cause your business to have a loss rather than profit), but it sets a standard deduction of $5 per square foot (up to $1,500) for whomever chooses to use this method, regardless of actual expenses. If you use this method you cannot deduct actual expenses. (See what home office expenses are deductible.)
Some considerations when choosing which method to use are:
Size of office - In order to use this simpler method you must have a home office that is smaller than 300 square feet. In the old method there was no limitation on the office size, but the deduction was calculated based on the percentage of the home used for business.
Schedule A deductions – Your deductions for mortgage interest, property taxes and other expenses, which can be partially deducted on Schedule A and partially as part of your home office deduction in the old method, can be fully deducted on Schedule A in the new method.
Depreciation deduction – If you own your home, in the old method you can take a depreciation deduction as part of your home office deduction. (However, taking this deduction can increase your capital gains tax when you eventually sell your home.) The new method does not allow you to take the depreciation deduction. If you use the simplified method for one year and use the regular method for a subsequent year, you must calculate the depreciation deduction for the subsequent year using an optional depreciation table.
Multiple businesses  If you have multiple businesses (owned by either the same or different people) in the same home, you must use the same home office deduction calculation method. Two different business owners (such as spouses) occupying the same home may each take the standard deduction for up to 300 square feet, as long as it is for different space within the home. The same person can only take the deduction on up to 300 square feet, even if it is for more than one business.
Multiple homes – If one business had a home office in two different homes (if you moved, for instance), you are only allowed to use the standard deduction (the simplified method) in one of the homes.
Calculating the deduction – To take the simplified deduction you calculate it on the Schedule C form in Part II. For the old method you still use IRS Form 8829 Expenses for Business Use of Your Home.
Posted on 10:35 AM | Categories:

Tax Savings for Empty-Nesters / Roll over an inherited 401(k), help your children earn a credit for retirement savings and rack up tax savings in the process.

The Editors of Kiplinger's Personal Finance magazine write: Empty-nesters should make these moves throughout the year to keep their bill low at tax time. Here are the areas where you should look for savings:

WORK

Give yourself a raise.
 If you got a big tax refund this year, it meant that you're having too much tax taken out of your paycheck every payday. Filing a new W-4 form with your employer (talk to your payroll office) will insure that you get more of your money when you earn it. If you're just average, you deserve about $225 a month extra. Try our easy withholding calculator now to see if you deserve more allowances.

Go for a health tax break. Be aggressive if your employer offers a medical reimbursement account -- sometimes called a flex plan. These plans let you divert part of your salary to an account which you can then tap to pay medical bills. The advantage? You avoid both income and Social Security tax on the money, and that can save you 20 percent to 35 percent or more compared with spending after-tax money. The maximum you can contribute to a health care flex plan is $2,500.

Stash cash in a self-employed retirement account. If you have your own business, you have several choices of tax-favored retirement accounts, including Keogh plans, Simplified Employee Pensions, or SEPs, and individual 401(k)s. Contributions cut your tax bill now while earnings grow tax-deferred for your retirement.

Don't be afraid of home-office rules. If you use part of your home regularly and exclusively for your business, you can qualify to deduct as home-office expenses some costs that are otherwise considered personal expenses, including part of your utility bills, insurance premiums and home maintenance costs. Some home-business operators steer away from these breaks for fear of an audit.
But a new IRS rule makes it easier to claim this tax break. Instead of calculating individual expenses, you can claim a standard deduction of $5 for every square foot of office space, up to 300 square feet.

Switch to a Roth 401(k). If your employer offers the new breed of 401(k), seriously consider opting for it. Unlike the regular 401(k), you don't get a tax break when your money goes into a Roth, but younger workers are often in lower tax brackets ... so the break isn't so impressive anyway. Also unlike a regular 401(k) money coming out of a Roth 401(k) in retirement will be tax-free at a time you may well be in a higher bracket.

Pay back a 401(k) loan before leaving the job. Failing to do so means the loan amount will be considered a distribution that will be taxed in your top bracket and, if you're younger than 55, hit with a 10 percent penalty, too.

Choose the right kind of business. Beyond choosing what business to go into, you also have to decide on the best form for your business: a sole proprietorship, a subchapter S corporation, a C-corp or a limited-liability company, or LLC. Your choice will have a major impact on your taxes.

HOME

Save energy, save taxes.
 Congress extended a $500 tax credit for energy-efficient home improvements, such as new windows, doors and skylights, through 2013. Be advised, though, that $500 is the lifetime maximum, so if you claimed $500 in energy-efficient credits before this year, you can't claim this credit. There are also restrictions on specific projects; for example, the maximum you can claim for new energy-efficient windows is $200.

Think green. A separate tax credit is available for homeowners who install alternative energy equipment. It equals 30 percent of what a homeowner spends on qualifying property such as solar electric systems, solar hot water heaters, geothermal heat pumps, and wind turbines, including labor costs. There is no cap on this tax credit, which is available through 2016.

Second homes can offer a vacation from taxes. If you're trying to figure whether you can afford a second home, remember that you'll get some help from the IRS. Mortgage interest on a loan to buy a second home is deductible just as it is for the mortgage on your principal residence. Interest on up to $1.1 million of first- and second-home debt can be deducted. Property taxes can be written off, too. Things get more complicated -- and perhaps more lucrative -- if you rent out the place part of the year to help cover the bills.

Watch the calendar at your vacation home. If you hope to deduct losses attributable to renting the place during the year, be careful not to use the house too much yourself.
As far as the IRS is concerned, "too much" is when personal use exceeds more than 14 days or more than 10 percent of the number of days the home is rented. Time you spend doing maintenance or repairs does not count as personal use, but time you let friends or relatives use the place for little or no rent does.

Take advantage of tax-free rental income. You may not think of yourself as a landlord, but if you live in an area that hosts an even that draws a crowd (a Super Bowl, say, or the presidential inauguration), renting out your home temporarily could make you a bundle -- tax free -- while getting out of town when tourists overrun the place. A special provision in the law lets you rent a home for up to 14 days a year without having to report a dime of the money you receive as income.

CHARITABLE CONTRIBUTIONS

Tote up out-of-pocket costs of doing good.
 Keep track of what you spend while doing charitable work, from what you spend on stamps for a fundraiser, to the cost of ingredients for casseroles you make for the homeless, to the number of miles you drive your car for charity (worth 14 cents a mile). Add such costs with your cash contributions when figuring your charitable contribution deduction.

Roll over an inherited 401(k). A recent change in the rules allows a beneficiary of a 401(k) plan to roll over the account into an IRA and stretch payouts (and the tax bill on them) over his or her lifetime. This can be a tremendous advantage over the old rules that generally required such accounts be cashed out, and all taxes paid, within five years. To qualify for this break, you must name a person or persons (not your estate) as your beneficiary. If your 401(k) goes through your estate, the old five-year rule applies.

INVESTMENTS AND RETIREMENT SAVINGS

Check the calendar before you sell.
 You must own an investment for more than one year for profit to qualify as a long-term gain and enjoy preferential tax rates. The "holding period" starts on the day after you buy a stock, mutual fund or other asset and ends on the day you sell it.

Don't buy a tax bill. Before you invest in a mutual fund near the end of the year, check to see when the fund will distribute dividends. On that day, the value of shares will fall by the amount paid. Buy just before the payout and the dividend will effectively rebate part of your purchase price, but you'll owe tax on the amount. Buy after the payout, and you'll get a lower price, and no tax bill.

Mine your portfolio for tax savings. Investors have significant control over their tax liability. As you near the end of the year, tote up gains and losses on sales to date and review your portfolio for paper gains and losses. If you have a net loss so far, you have an opportunity to take some profit tax free.

Alternatively, a net profit on previous sales can be offset by realizing losses on sales before the end of the year. (This strategy applies only to assets held in taxable accounts, not tax-deferred retirement accounts such as IRAs or 401(k) plans).

Consider tax-free bonds. It's easy to figure whether you'll come out ahead with taxable or tax-free bonds. Simply divide the tax-free yield by 1 minus your federal tax bracket to find the "taxable-equivalent yield." If you're in the 33 percent bracket, your divisor would be 0.67 (1 - 0.33). So, a tax-free bond paying 5 percent would be worth as much to you as a taxable bond paying 7.46 percent (5/0.67).

Keep a running tally of your basis. For assets you buy, your "tax basis" is basically how much you have invested. It's the amount from which gain or loss is figured when you sell. If you use dividends to purchase additional shares, each purchase adds to your basis. If a stock splits or you receive a return-of-capital distribution, your basis changes. Only by carefully tracking your basis can you protect yourself from overpaying taxes on your profits when you sell.

A new IRS rule requires financial services and brokerage firms to report to the IRS the cost basis for stocks purchased on or after January 1, 2011 and mutual funds purchased on or after January 2, 2012. They'll also provide you with this information, which should make it easier for you to avoid costly mistakes when you sell. For older shares, though, you'll still need to track your basis to avoid overpaying taxes on your profits.

Beware of Uncle Sam's interest in your divorce. Watch the tax basis -- that is, the value from which gains or losses will be determined when property is sold -- when working toward an equitable property settlement. One $100,000 asset might be worth a lot more -- or a lot less -- than another, after the IRS gets its share. Remember: Alimony is deductible by the payer and taxable income to the recipient; a property settlement is neither deductible nor taxable.

Help your children earn a credit for retirement savings. This credit can be as much as $1,000, based on up to 50 percent of the first $2,000 contributed to an IRA or company retirement plan. It's available only to low-income taxpayers, who are often the least able to afford such contributions. Parents can help, however, by giving an adult child (who can not be claimed as a dependent) the money to fund the retirement account contribution. The child not only saves on taxes but also saves for his or her retirement.
Posted on 10:35 AM | Categories:

Definitive Guide To 2014 ETF Taxation

 Dennis Hudachek for ETF.com writes:  2014 Update: 2013 saw a host of changes to tax rates for individuals in the highest tax brackets. This year, our guide has been fully updated with information related to the taxation of MLPs, buy-writes, wash-sale rules on collectibles, new ETF structures, regulated investment company rules and the taxation of distributions detailed by asset class and structure. 

Note: This ETF Taxation Guide will be available in PDF format in the coming weeks, along with a PDF cheat sheet, which will be housed in our "White Papers" link under the "Sections" tab on our ETF.com site.

Table of Contents
  1. Introduction
  2. What Drives ETF Taxation
  3. Equity and Fixed Income Funds
    1. Taxation of Regulated Investment Companies
  4. Commodity ETFs
    1. Commodity Grantor Trusts
    2. Commodity Limited Partnerships
    3. Commodity ETNs
  5. Currency ETFs
    1. Currency Open-Ended Funds
    2. Currency Grantor Trusts
    3. Currency Limited Partnerships
    4. Currency ETNs
  6. Alternative ETFs
  7. Taxation of Distributions
    1. Equity ETFs
    2. Fixed-Income ETFs
    3. Commodity ETFs
    4. Currency ETFs
    5. Return of Capital
    6. MLP ETFs
    7. Buy-write ETFs
    8. Tying It All Together
  8. Appendix: 2013 Capital Gains Tax Changes
    1. Medicare Surcharge Tax
    2. Tax Tables
Introduction
Investors spend hours researching funds for expense ratios and spreads, trying to save a few basis points here and there. But often, not enough time is spent researching a fund's structure and the associated tax implications.

Based on how the ETF's distributions are taxed and the taxation of gains when shares are eventually sold, the different tax implications can translate into hundreds or even thousands of basis points.

Investor confusion over tax treatments comes from many sources. Partly, it's because ETF taxation is complicated. Partly, it's because taxes are boring. And partly, it's because ETF issuers provide unclear tax guidance in many prospectuses.

Whatever the reason, we at ETF.com think investors deserve better, so we prepared this document to provide complete guidance on how different ETFs are treated by the tax man.
What Drives ETF Taxation
An ETF's taxation is ultimately driven by its underlying holdings. Since funds are structured differently according to how they gain exposure to the underlying asset, an exchange-traded product's tax treatment inherently depends on both the asset class it covers and its particular structure.

A fund's asset class can be classified in one of five categories: equities; fixed income; commodities; currencies; and alternatives.

For tax purposes, exchange-traded products come in one of five structures: open-end funds; unit investment trusts (UITs); grantor trusts; limited partnerships (LPs); and exchange-traded notes (ETNs).

Many commodity and currency funds that hold futures contracts are regulated by the Commodity Futures Trading Commission (CFTC) as commodities pools, but they're classified as limited partnerships for tax purposes by the IRS. Therefore, "limited partnership" will be used to refer to the structure of these funds throughout this paper.

This five-by-five matrix—five asset classes and five fund structures—defines all the potential tax treatments available in the ETF space. In this paper, we'll use asset class as the primary sort, as that is the easiest way to classify and think about funds.

Note: The tax rates we're about to discuss are the maximum long-term and short-term capital gains rates. The rates listed in the tables for each respective asset classes do not include the Medicare surcharge tax of 3.8 percent applicable to certain investors. Long-term capital gains apply to positions held for longer than one year; short-term capital gains apply to positions held for one year or less.
Equity And Fixed-Income Funds
Equity and fixed-income ETFs currently operate in three different structures: open-end funds, unit investment trust or ETNs.

MAXIMUM CAP GAINS TAX RATE
STRUCTURELong-TermShort-Term
Open End (40 Act)20.00%39.60%
UIT (40 Act)20.00%39.60%
Grantor Trust (33 Act)N/AN/A
Limited Partnership (33 Act)N/AN/A
ETN (33 Act)20.00%39.60%
Most all equity and fixed-income ETFs are structured as open-ended ETFs. Examples of open-end funds include the iShares EFA ETF (EFA | A-89), the Vanguard FTSE Emerging Markets Index ETF (VWO | C-89) and the iShares Barclays TIPS Bond Fund (TIP | A-99).
Still, there are a handful of funds structured as UITs. Some of the first ETFs on the market were structured as such, and include the SPDR S&P 500 Fund (SPY | A-97), the PowerShares Nasdaq 100 ETF (QQQ | A-63) and the SPDR Dow Jones Industrial ETF (DIA | A-70).

There are some peculiarities associated with UITs that investors should understand. First, UITs must fully replicate their indexes (as opposed to optimizing their portfolios). UITs also cannot reinvest dividends from their holdings back into the trust the way open-ended funds can, which creates some "cash drag" in these specific products.

Then there are a select few ETNs, such as the iPath MSCI India Index ETN (INP | C-94) and the Etracs Wells Fargo Business Development Company ETN (BDCS).

Fortunately, all three structures receive the same tax treatment: The long-term capital gains rate is 20 percent if shares are held for more than one year; if shares are held for one year or less, gains are taxed as ordinary income—with a maximum rate of 39.60 percent.
Taxation Of Regulated Investment Companies
You've probably noticed that a single position in most ETFs never exceeds 25 percent of its total weighting. Or for that matter, you may have noticed that a fund tracks a "25/50" index. This is because an ETF must abide by certain diversification rules to qualify as a regulated investment company (RIC) under Regulation M in the eyes of the IRS.

While there are many requirements to qualify as a RIC, one of those requirements addresses diversification: A single holding in a RIC cannot exceed 25 percent, and the aggregate of all positions over 5 percent cannot exceed 50 percent of the fund's total weighting.

It's important to stay RIC compliant to avoid double taxation. If an ETF isn't taxed as a RIC, it gets taxed on its dividends and gains from its holdings like a corporation, and investors get taxed again on their distributions.

For the fund to avoid being taxed at the fund level, it must distribute all of its taxable income from dividends, as well as any net capital gains to its shareholders. In doing so and qualifying as a RIC, the fund is eligible to pass on gains to its shareholders directly without paying taxes itself.

Two Notable Exceptions:

Most ETFs tracking the master limited partnership (MLP) market are structured as open-ended funds, but classified by the IRS as C corporations for taxation purposes. While the taxation of gains from selling fund shares is the same as for other equity ETFs, the distribution of these products is complex, and highlighted under MLP ETFs in the "Taxation of Distributions" section of this paper.

The PowerShares China A-shares ETF (CHNA) is currently the only equity ETF that is regulated by the CFTC as a commodities pool, but is structured as an open-ended fund. CNHA holds a futures contract traded in Singapore that's tied to the FTSE China A50 Index. Since CHNA holds an equity-linked futures contract, the taxation of gains on share sales is similar to the way other equity ETFs are taxed.
Commodity ETFs
Commodity ETFs generally come in one of three structures: grantor trusts; limited partnerships; or ETNs. The lone exception is the First Trust Global Tactical Commodity Strategy Fund (FTGC), which is structured as an open-ended fund.

Knowing the structure of commodity funds is crucial, since the tax implications differ dramatically between the various structures.

MAXIMUM CAP GAINS TAX RATE
STRUCTURELong-TermShort-Term
Open End (40 Act)20.00%39.60%
UIT (40 Act)N/AN/A
Grantor Trust (33 Act)28.00%39.60%
Limited Partnership (33 Act)*27.84%**27.84%**
ETN (33 Act)20.00%39.60%
Distributes K-1
**Max rate of blended 60% LT/40% ST
Commodity Grantor Trusts
Grantor trust structures are used for "physically held" precious metals ETFs, such as the SPDR Gold Shares (GLD | A-100), the iShares Gold Trust (IAU | A-99) and the iShares Silver Trust (SLV | A-99). These and related funds store the physical commodity in vaults, giving investors direct exposure to spot returns.

Under current IRS rules, investments in these precious metals ETFs are considered collectibles. Collectibles never qualify for the 20 percent long-term tax rate applied to traditional equity investments; instead, long-term gains are taxed at a maximum rate of 28 percent. If shares are held for one year or less, gains are taxed as ordinary income, again at a maximum rate of 39.60 percent.

There's a growing consensus that the wash-sale rule does not apply to collectibles. If the wash-sale rule were to not apply to commodity grantor trusts, it means investors can literally sell one product like GLD to realize their losses, then immediately jump right back into a practically identical ETF like IAU (which happens to be 15 basis points less in expenses than GLD).

That said, there's currently no direct ruling from the IRS regarding commodity grantor trust ETFs and the wash-sale rule, so a discussion with a tax professional is advised regarding this issue.
Commodity Limited Partnerships
Many ETFs hold futures contracts to gain exposure to commodities and are structured as limited partnerships (LPs).

Some commodity funds structured as LPs include the PowerShares DB Commodity Index Tracking Fund (DBC | B-69), the United States Natural Gas Fund (UNG | A-78) and the iShares S&P GSCI Commodity-Indexed Trust (GSG | C-90). There are even ETFs that invest in precious metals futures, which stand in contrast to the physically backed funds mentioned earlier.

Futures-based funds have unique tax implications. Currently, 60 percent of any gains are taxed at the long-term capital gains rate of 20 percent, and the remaining 40 percent is taxed at the investor's ordinary income rate, regardless of how long the shares are held. This comes out to a blended maximum capital gains rate of 27.84 percent.

Limited partnership ETFs are considered pass-through investments, so any gains made by the trust are "marked to market" at the end of each year and passed on to its investors, potentially creating a taxable event. This means your cost basis adjusts at year-end, and you can be subject to pay taxes on gains regardless of whether or not you sold your shares.

For tax reporting, limited partnership ETFs also generate a Schedule K-1 form. This can create uncertainty and annoyance for the average investor not familiar with K-1s when they receive these forms in the mail.
Commodity ETNs
Commodity ETNs do not hold the physical commodity, nor do they hold futures contracts. They are unsubordinated, unsecured debt notes issued by banks that promise to provide the return of a specific index. Therefore, commodity ETNs carry credit risk: If the bank issuing the note goes bankrupt or defaults, investors can lose their entire investment.

Popular commodity ETNs include the iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP | A-22), the Elements Rogers International Commodity Total Return ETN (RJI | C-35) and the iPath S&P GSCI Crude Oil Total Return Index ETN (OIL | A-92).

Commodity ETNs are currently taxed like equity and/or bond funds. Long-term gains are taxed at 20 percent, while short-term gains are taxed as ordinary income (maximum 39.60 percent). Despite the fact that many of these products track futures-based indexes, they do not generate a K-1.

A Notable Exception

The First Trust Global Tactical Commodity Strategy Fund (FTGC) is the only futures-based commodity ETF structured as an open-ended fund. FTGC gains its exposure to commodity futures contracts through a subsidiary in the Cayman Islands. The subsidiary, as opposed to the fund itself, invests in futures contracts.

FTGC limits its exposure in this subsidiary to 25 percent, thereby staying RIC compliant for taxation purposes. It parks its cash collateral in Treasury bills. By using this unique structure, FTGC is able to access futures contracts without having to distribute K-1 forms to its shareholders.
Currency ETFs
Currency ETFs come in one of four structures: open-end funds; grantor trusts; limited partnerships; or ETNs.
MAXIMUM CAP GAINS TAX RATE
STRUCTURELong-TermShort-Term
Open End (40 Act)20.00%39.60%
UIT (40 Act)N/AN/A
Grantor Trust (33 Act)39.60%39.60%
Limited Partnership (33 Act)*27.84%**27.84%**
ETN (33 Act)39.60%39.60%
Distributes K-1
**Max rate of blended 60% LT/40% ST
Currency Open-Ended Funds
WisdomTree and Pimco are currently the only issuers to offer currency ETFs structured as open-end funds. Some popular open-ended currency funds include the WisdomTree Dreyfus Chinese Yuan Fund (CYB | B-61), the WisdomTree Dreyfus Brazilian Real Fund (BZF | B-91), the Pimco Foreign Currency ETF (FORX | B-35) and the WisdomTree US Dollar Bullish Fund (USDU).

Open-ended currency funds do not hold currency notes or futures contracts. Instead, they mostly hold the bulk of their assets in U.S. Treasury bills and repurchase agreements (repos), while gaining exposure to the reference currencies through forward currency contracts (and sometimes swaps).

Tax implications for these funds are similar to equity funds. When shares are sold, gains are taxed as long-term capital gains (20 percent) if held for more than one year; if held for one year or less, gains are taxed as ordinary income (maximum 39.60 percent).

That said, most of a fund's gains from its forward currency contracts (its actual exposure to the targeted currency) get distributed to its shareholders quarterly or annually, and those distributions are generally taxed at the same blended rates that futures contracts are taxed at (see "Currency ETFs" in the "Taxation of Distributions" section).
Currency Grantor Trusts
CurrencyShares are structured as grantor trusts. Each CurrencyShares product gives investors exposure to spot exchange rates of the underlying currency by holding the foreign currency in bank accounts. The most popular CurrencyShares are currently the Canadian Dollar Trust (FXC | A-99), the Swiss Franc Trust (FXF | B-99) and the Australian Dollar Trust (FXA | A-99).

The taxation of CurrencyShares products is straightforward. All gains from the sale of shares are taxed as ordinary income (maximum 39.6 percent), regardless of how long they're held by the investor.
Currency Limited Partnerships
Similar to commodity LP funds, currency funds that hold futures contracts are structured as LPs. These funds include the PowerShares DB US Dollar Index Bearish and Bullish Funds ((UDN | B-40) and (UUP | B-39), respectively) as well as leveraged currency funds such as the ProShares UltraShort Euro Fund (EUO) and the ProShares UltraShort Yen Fund (YCS).

The tax implications for currency limited partnership ETFs are the same as commodity limited partnership ETFs—gains are subject to the same 60 percent/40 percent blend, regardless of how long the shares are held. They're also marked to market at year-end and are reported on K-1s.
Currency ETNs
Some uncertainty surrounds the taxation of currency ETNs. Due to an IRS ruling in late 2007—Revenue Ruling 2008-1—gains from currency ETNs are now generally taxed as ordinary income (maximum 39.60 percent), regardless of how long the shares are held by the investor.

However, according to the prospectuses of some currency ETNs, investors might have an option to classify gains as long-term capital gains if a valid election under Section 988 is made before the end of the day that the ETN was purchased.

As with all ETNs, not only do currency ETNs carry counterparty risk, but the entire value of the note is dependent on the credit of the issuing bank.

Some currency ETPs structured as exchange-traded notes include the Market Vectors Chinese Renminbi/USD ETN (CNY | C-59), the iPath EUR/USD Exchange Rate ETN (ERO | C-96) and the PowerShares DB 3X Long US Dollar Index ETN (UUPT).
Alternative ETFS
Alternative funds seek to provide diversification by combining asset classes or investing in nontraditional assets, and generally come in one of three structures: open-end funds; limited partnerships; or ETNs.
MAXIMUM CAP GAINS TAX RATE
STRUCTURELong-TermShort-Term
Open End (40 Act)20.00%39.60%
UIT (40 Act)N/AN/A
Grantor Trust (33 Act)N/AN/A
Limited Partnership (33 Act)*27.84%**27.84%**
ETN (33 Act)20.00%39.60%
Distributes K-1
**Max rate of blended 60% LT/40% ST
The construction of many alternative ETFs can be complicated, but the taxation of gains made from selling shares in the funds falls in line with their respective structures.
Managed-futures funds like the WisdomTree Managed Futures Strategy Fund (WDTI | B-91) hold futures contracts in a subsidiary in the Cayman Islands. These funds limit the weighting to their subsidiary to 25 percent, making them RIC compliant. Since they're structured as open-ended funds, gains are taxed the way most equity ETFs are taxed.

While the taxation of distributions of buy-write ETFs like the PowerShares S&P 500 BuyWrite ETF (PBP | D-52) are complex, gains made from selling shares are taxed just like other equity funds (see "Buy-write ETFs" in the "Taxation of Distributions" section).

Alternative funds that hold futures contracts directly like some volatility, commodity and currency funds are structured as LPs and taxed as such. All gains are taxed at the blended 60 percent/40 percent rate, regardless of holding period, creating a maximum blended tax rate of 27.84 percent. Examples include the PowerShares DB G10 Currency Harvest Fund (DBV | B-59) and the ProShares VIX Short-Term Futures Fund (VIXY | A-54).

Finally, alternative funds structured as ETNs currently have the same tax implications on gains from share sales as other equity ETNs.

One Notable Exception

The iPath Optimized Currency Carry ETN (ICI | C-47) is an exception to the rule regarding alternative ETNs. ICI is considered a currency ETN for tax purposes, with gains from sales that generally get taxed as ordinary income regardless of how long shares are held.
Taxation of Distributions
Besides taxes on capital gains incurred from selling shares of ETFs, investors also pay taxes on periodic distributions paid out to shareholders throughout the year. These distributions can be from dividends paid out from the underlying stock holdings, interest from bond holdings, return of capital or capital gains—which come in two forms: long-term gains and short-term gains. The good news is that most of the time, this will be indicated directly on any 1099s received. Still, for planning purposes, it's important to know what you can expect.

Distributions from ETFs are usually paid out monthly, quarterly, semiannually or annually.
Equity ETFs
Most equity ETFs hold companies that pay dividends in their portfolios. There are two kinds of dividends that investors should be aware of: qualified dividends and nonqualified dividends.

Qualified dividends are dividends paid out from a U.S. company whose shares have been held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. Importantly, this refers to the shares held by the ETF itself, and not the holding period of investors in the ETF.

Qualified dividends are taxed at a maximum rate of 20 percent, compared with nonqualified dividends, which are taxed as ordinary income. Many of the dividends paid out to shareholders in domestic equity ETFs are qualified dividends.

REITs fall into their own category when it comes to the taxation of its distributions. Generally, distributions from REITs are all taxed as ordinary income, so for investors in many equity real estate ETFs dominated by REITs, much of your distributions are likely to be taxed like ordinary income rather than qualified dividends.

Equity ETNs don't hold any securities, but generally track total return indexes. These indexes capitalize all distributions back in the index.
Fixed-Income ETFs
Investors should keep in mind that while monthly distributions from bond ETFs are often called "dividends," interest from the underlying bond holdings aren't considered qualified dividends and are taxed as ordinary income.
Commodity ETFs
Commodity funds that hold futures contracts rarely pay out distributions. Still, some funds park their cash collateral in U.S. Treasury bills, and at times can pay out distributions from interest payments gained in those holdings. Those distributions are taxed as ordinary income.
Currency ETFs
Distributions are often a large component of currencies, so it pays to understand the ins and outs of currency ETF distributions, as they can be tricky.

CurrencyShares products structured as grantor trusts distribute the interest accrued from its underlying currency holdings. Those are paid out monthly and taxed as ordinary income.

Some currency ETFs structured as open-ended funds, such as WisdomTree's products, pay out distributions from its holdings in Treasury bills and from gains made in its forward currency contracts. Distributions from its T-bill holdings are taxed as ordinary income, while distributions from gains made in forward contracts are generally taxed the way futures are taxed: at the "60 percent/40 percent" blended long-term and short-term rate.

Most currency ETNs don't pay out any distributions to its shareholders. But if they do, distributions are taxed as ordinary income. Also, if a note generates any income that's not distributed throughout the year, investors can still be subject to pay taxes on this "phantom income" at year end, making currency ETNs particularly tax ineffective.
Return Of Capital
While the vast majority of ETFs make simple distributions, funds can also pay out distributions in excess of the fund's earnings and profits called return of capital (ROC). ROC distributions are generally nontaxable and reduces the investor's cost basis by the amount of the distribution. While any fund can theoretically make ROC distributions, it's common in master limited partnership funds, such as the Alerian Master Limited Partnership Fund (AMLP).

MLP ETFs

The taxation of MLP ETF distributions is complex. Most MLP ETFs are structured as open-ended funds, but classified by the IRS as C corporations for taxation purposes. For these types of funds, most of their distributions are ROC, which is not a taxable event, but lowers your cost basis by the amount of the distribution at year end.

There are also a handful of MLP funds structured as open-ended funds that are not classified as C corporations by the IRS and are instead taxed like RICs. These funds mostly hold energy infrastructure companies, and contain their exposure to actual MLPs to under 25 percent. Distributions from these ETFs are generally a mixture of qualified dividends and ROC.

MLP ETNs are much simpler. Distributions from them are all taxed as ordinary income.

The great part about MLP ETFs is that regardless of their structures, investors don't have to deal with K-1 forms, since tax reporting is done on 1099s.

It's worth acknowledging that this is a significant oversimplification of everything that goes on "under the hood" of a modern MLP ETF from a tax perspective, if you want to do a deeper dive into the complexities around the tax implications of MLP ETFs, see our white paper, The Definitive Guide to MLP ETFs and ETNs.

Buy-write ETFs

The taxation of distributions from buy-write ETFs is a subject of deep confusion for many investors. That's because the taxation of covered-call strategies is a complex matter that could make even a tax advisor's head spin.

Generally, most distributions from buy-write ETFs and gains made from the covered-call strategies are taxed at short-term capital gains rates. Still, it's important to differentiate between stock options and index options, as their tax implications are different.

Some ETFs, including the PowerShares S&P 500 BuyWrite ETF (PBP | D-52), overlay their stock holdings with an index option. Index options generally are taxed the way futures contracts are taxed—at the 60 percent/40 percent blended rate.

Other buy-write ETFs, such as the Horizons S&P 500 Covered Call ETF (HSPX), write stock options on each individual holding. Complicating the matter, the taxation of gains can vary depending on whether the covered-call strategy is considered "qualified" or "unqualified."

(To be considered a qualified covered call, the option must be at-the-money or out-of-the-money, with 30 or more days till expiration.)

Furthermore, tax implications can differ, once again, depending on if the strategy is deemed to be a "straddle" that certain buy-write ETFs fall under.

The taxation of covered-call strategies is highly complex, so we strongly advise consulting a tax advisor for tax details regarding the distributions around these products. Alternatively, investors can limit their use to nontaxable accounts.
Tying It All Together
Fortunately for investors, all the various distributions are broken down in the 1099-DIV at year-end. The 1099-DIV will first show "Total Ordinary Dividends," which includes both qualified and nonqualified dividends, as well as any short-term capital gains. Qualified dividends that are subject to the beneficial 20 percent tax rate are further separated under the "Qualified Dividends" heading.

Any long-term capital gains that qualify for the 20 percent rate are separated as well, listed under the heading "Total Capital Gains Distributions." ROC distributions should be included in the "Nondividend Distributions" section on the 1099-DIV.
Appendix: 2013 Capital Gains Tax Changes
Effective Jan. 1, 2013, due to the passing of the American Taxpayer Relief Act of 2012, singles with taxable income over $400,000, and married filing jointly with taxable income over $450,000 are now subject to higher capital-gains tax rates.

For investors in this higher tax bracket, long-term capital gains rates have increased from 15 to 20 percent, while short-term capital-gains rates increased from 35 to 39.6 percent. Qualified dividends are also now taxed at this new 20 percent rate, while interest income from bond funds will continue to be subject to ordinary income rates, or a maximum of 39.60 percent.

For all other filers with a taxable income equal to or less than the $400,000/$450,000 threshold, all rates on capital gains and qualified dividends remain the same as in 2012 (excluding the Medicare tax, which is a separate tax with a different income threshold), with maximum long-term capital gains and qualified dividends still taxed at a 15 percent rate, and maximum short-term rates taxed at 35 percent.
Medicare Surcharge Tax
Effective Jan. 1, 2013, due to the passing of the Patient Protection and Affordable Care Act, singles with an adjusted gross income (AGI) over $200,000 and married filing jointly with an AGI over $250,000 are now subject to an additional 3.8 percent Medicare surcharge tax on investment income, which includes all capital gains, interest and dividends.

This new tax will be levied on the lesser of net investment income or modified AGI in excess of $200,000 single/$250,000 joint. Therefore, for investors in the highest tax brackets, their "true" tax rates on long-term capital gains and qualified dividends can reach 23.8 percent (20 percent capital gains plus 3.8 percent Medicare tax).
Tax Tables
Max LT/ST Capital Gains Rates (Taxable Income Equal to or Less than $400K Single/$450K Joint)
Equity & Fixed IncomeCommodityCurrencyAlternative
FUND STRUCTURE
Open End (40's Act)15/3515/3515/3515/35
UIT (40's Act)15/35N/AN/AN/A
Grantor Trust (33 Act)N/A28/3535/35N/A
Limited Partnership (33 Act)N/A23/23*23/23*23/23*
ETN (33 Act)15/3515/3535/3515/35









*Max blended rate of 60% LT/40% ST
NOTE: These rates are NOT inclusive of the 3.8% Medicare surcharge tax or any additional taxes applicable from the phaseout of itemized deductions and personal exemptions.
Max LT/ST Capital Gains Rates (Taxable Income Greater than $400K Single/$450K Joint)
Equity & Fixed IncomeCommodityCurrencyAlternative
FUND STRUCTURE
Open End (40's Act)20/39.6020/39.6020/39.6020/39.60
UIT (40's Act)20/39.60N/AN/AN/A
Grantor Trust (33 Act)N/A28/39.6039.60/39.60N/A
Limited Partnership (33 Act)N/A27.84/27.84*27.84/27.84*27.84/27.84*
ETN (33 Act)20/39.6020/39.6039.60/39.6020/39.60










*Max blended rate of 60% LT/40% ST
NOTE: These rates are NOT inclusive of the 3.8% Medicare surcharge tax or any additional taxes applicable from the phaseout of itemized deductions and personal exemptions.

Disclaimer: We are not professional tax advisors. This article is for informational purposes only and not intended to be tax advice. Tax rules can change. Individuals should always consult with a professional tax advisor for details about the tax implications of investment products and their personal taxes.

Posted on 10:35 AM | Categories: