I’m sure you’ve all heard the mantra for why ETFs are better than mutual funds: They’re cheaper, have greater transparency and flexibility and are much more tax efficient. That’s definitely true for ETFs that are structured at investment companies under the 1940 Act. These ETFs, which typically hold stocks or bonds, report their taxable gains and losses on IRS Form 1099.
However, some exchange-traded products are structured as partnerships, such as the ones that hold shares of master limited partnerships or futures contracts for commodities, currencies or volatility. Because of the creation/redemption system of acquiring securities, most ETFs don’t post capital gains. That means an investor only pays capital gains when he or she sells the shares in the fund.
However, limited partnerships pass through their taxes to the investor/partners every year. So investors need to pay taxes on any profits earned during the year. These investors receive a K-1 tax form, which outlines their profits or losses in the partnership over the past year. It’s a complicated form that can make figuring out and reporting taxes a big headache.
ETF Database has created what it calls the Complete List of ETFs that Issue K-1s. It’s a good list, but I don’t think it’s complete. It doesn’t list any of the ETFs that track master limited partnerships, which are usually companies that deal with natural resources.
Nonetheless, this is a good starting point on whether you should expect to receive a K-1 form from your ETP this year.