The ETF Tax Loophole

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Bloomberg Feb 26 22:59 · 21.1k Views

A year-old investment fund offers returns that closely track short-term Treasuries, with starkly lower tax bills. The fund, Alpha Architect 1-3 Month Box ETF (BOXX), uses a complex options strategy and a longstanding tax loophole that favors exchange-traded funds. Bloomberg's Zachary Mider explains.

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Transcript

  • 00:00 So explain how Box works because it promises returns like Treasury bills, but it's not exactly the same as investing in Treasury bills.
  • 00:07 Exactly.
  • 00:08 They don't own any Treasuries,
  • 00:10 but they
  • 00:11 produce returns that are almost the same by
  • 00:13 a bunch of complicated options trading.
  • 00:16 But what's interesting is that if you own AT bill ETF,
  • 00:19 you have to pay tax every year at relatively high rates on the income, on the earnings of the the Treasuries generate.
  • 00:26 With Box, you get no tax bill until you sell and even then potentially a lower rate.
  • 00:32 And this is so interesting because I feel like I knew about this ETF I knew when it launched, but I didn't realize that it had this interesting nuance to it.
  • 00:41 So
  • 00:42 immediate question of course that comes up is
  • 00:44 why would I go through this ETF?
  • 00:46 How does this compare to just outright buying T-bills,
  • 00:49 right?
  • 00:49 Well, the difference first of all is
  • 00:51 it's the government.
  • 00:52 If you buy T-bills here, you're hoping that these guys are
  • 00:56 not making some kind of mistake with the options.
  • 00:58 And your counterparty is
  • 01:00 not the US government.
  • 01:01 It's very highly rated, but it's not the US government.
  • 01:03 So there's real, you know, potential risks you have to consider there.
  • 01:07 Plus, you know, the, the tax treatment, depending on who you are and what state you live in, might be a little more complicated.
  • 01:14 But generally it's
  • 01:15 it's,
  • 01:16 you know, it's it's a big
  • 01:17 tax advantage for a lot of people.
  • 01:19 Tax advantage means it's going to get a lot of eyeballs in Washington.
  • 01:23 And Congress is taking a look at this.
  • 01:24 What's the latest on that front?
  • 01:26 Right.
  • 01:26 So
  • 01:27 Democrats in Congress have made noise in the past about closing the ETF loophole.
  • 01:34 It's estimated to cost about $20 billion a year.
  • 01:37 And so
  • 01:39 people in the ETF world, meanwhile, are just trying to find ways to put new things through the loophole like box.
  • 01:45 And so
  • 01:46 to the extent they're successful that'll that could potentially make
  • 01:49 an even bigger target in Washington.
  • 01:51 If that happened, that would be like existential.
  • 01:54 By the way, we have an ETFIQ special, I know
  • 01:57 exactly we do an emergency show there.
  • 01:59 But when it comes to like you said, I mean ETF issuers trying to fit other things through the loophole,
  • 02:05 Could we see other issuers go with this strategy or does it only specifically work with T-bills?
  • 02:10 What have you heard around those lines?
  • 02:13 It's hard to know.
  • 02:14 Definitely.
  • 02:14 There are other people working on similar things.
  • 02:17 But there's also other things that you could hardly imagine
  • 02:20 that involve this using the same loophole.
  • 02:23 Like imagine you had a hedge fund
  • 02:25 and you turned it into an ETF so you could sell your appreciated positions without a tax bill.
  • 02:30 That's the kind of thing that people are, are trying to imagine.
  • 02:33 You know, we have this like, great loophole, like, let's try to use it in new and creative ways.