The Treasury Department has expressed concern over a tax strategy employed by exchange-traded funds (ETFs) that enables investors, particularly high-earners, to significantly reduce or defer capital gains taxes. This practice, referred to as "conversions," is currently under scrutiny by the Treasury, which views it as potentially abusive.
Bloomberg estimates indicate that this loophole costs the US government $48 billion a year in lost tax revenue. The benefits largely accrue to the wealthiest Americans; the highest-earning 1% of households save approximately $13,000 annually on average, while those in the middle of the wealth distribution save about $23. Should the entire mutual fund industry adopt an ETF share class, the richest taxpayers could see an additional $11,000 in savings.
There is a potential for these tax savings to nearly double following recent policy shifts. If the entire mutual fund industry were to utilize ETFs to wash out capital gains, it could lead to around $40 billion in additional deferred or avoided taxes each year, with $35 billion impacting individuals and $4 billion affecting businesses. The IRS is moving forward with rules regarding abusive deals in anticipation of increased litigation over these strategies.
