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How Is ETF Income Taxed?

Because ETFs are structured and traded differently than mutual funds, ETFs typically realize fewer capital gains, making them one of the more tax-efficient investments you can own.

If you invest in ETFs that generate significant income from payouts, however, taxes might be of greater concern. “Dividends and interest are treated differently and should therefore be a factor when selecting funds for your portfolio,” says Emily Doak, CFA and managing director of ETF research at Charles Schwab Investment Advisory.

For example, most dividends from ETFs holding U.S. stocks are considered “qualified” for federal tax purposes, meaning they’re taxed at the long-term capital gains rate of 0%, 15%, or 20%, depending on your income.1 (By contrast, nonqualified dividends are treated as ordinary income, meaning they could be taxed as much as 37% for high-income earners.) But to qualify for the long-term capital gains rate, you must meet certain holding period requirements; if you don’t, your dividends will be subject to ordinary income tax rates.2

Interest payouts from taxable bond ETFs, on the other hand, are always taxed as ordinary income, irrespective of how long you’ve held the fund. So, if generating tax-efficient income is one of your goals, you might instead want to consider municipal bond ETFs, which are tax-free at the federal level (and sometimes at the state level, depending on where you reside).

Of course, taxes are only one consideration among many when selecting investments for your portfolio. Regardless of how their payouts are taxed, funds also need to support your investment goals or income needs. Fortunately, ETFs remain one of the most tax-efficient ways to reach your long-term objectives.

1An additional 3.8% surtax may apply for high-income earners with significant investment income. | 2Payments from securities-lending revenue and income from options strategies are not eligible for qualified tax treatment. For more details, see IRS Publication 550, “Investment Income and Expenses."

What You Can Do Next

  • Read more about managing your tax bill.

     

  • Schwab clients can keep tabs on their income payouts with the new Investment Income function on schwab.com. Log in today to view year-to-date and estimated remaining income payouts for each of your Schwab accounts.

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Important Disclosures:

Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV). All ETFs are subject to management fees and expenses.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

Charles Schwab Investment Advisory is a division of Charles Schwab & Co., Inc.

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