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Exchange-Traded Notes (ETNs) Tax Treatment

ETNs may have different tax treatment dependent on their structure.

Exchange-traded funds (ETFs) and exchange-traded notes (ETNs) are often grouped together since they have many similarities. ETFs represent a stake in an underlying commodity, therefore they are generally taxed like other securities realizing capital gains or losses, and IRS Section 1091 wash sale rules apply. However, ETNs are structured differently as a type of unsecured, unsubordinated debt security. ETNs don’t own any underlying assets of the underlying index or benchmark they are based on; therefore, different tax treatment may apply for some products.

The IRS has provided little definitive guidance on tax treatment for these products. However, leading tax experts have published strong support in recent years for their positions regarding ETN treatment.

Generally, we can categorize ETNs in three ways for considering tax treatment:

  1. Foreign currency ETN
  2. ETN structured as a debt security
  3. ETN structured as a prepaid forward contract (or prepaid executory contract)

Foreign Currency ETNs

The IRS has provided clear guidance for this type of ETN. In Rev. Ruling 2008-1 the IRS holds that foreign currency ETNs are considered debt for tax purposes, which results in the application of Section 988. Therefore, currency ETNs are treated as ordinary gain or loss. They cannot benefit from long-term capital gains rates and tax deferral.

TradeLog software segregates trades for Section 988 treatment. In the past, a trader would need to identify currency ETNs and manually change the type/multiplier for currency treatment. TradeLog now recognizes defined currency ETNs based on Global Options settings, flagging these with the type/multiplier code CTN-1. These trades will then be properly reported on TradeLog’s Forex/Currencies report, providing the needed details for Section 988.

ETNs Structured as Debt Securities

The structure of an ETN, as outlined in the prospectus, may be as a debt instrument/security. In this case the trades would be taxed like other securities, realizing capital gains or losses. Section 1091 wash sale rules would apply.

TradeLog Software recognizes defined ETF/ETN symbols based on Global Options settings. The type/multiplier code of ETF-1 is used for ETNs structured as debt securities. (This is the same treatment for most ETFs.) These trades will be reported on the Form 8949 generated by TradeLog. If Section 475 mark to market accounting (MTM) has been elected for the account, the software will then report these trades on Form 4797 (in which case wash sale rules will not apply).

ETNs Structured as Prepaid Forward Contracts (or Prepaid Executory Contracts)

Other ETNs are structured as prepaid forward contracts (also known as prepaid executory contracts), as evident by the ETN prospectus. These are based on the movement of an underlying financial instrument, futures index, or equities index – and do not hold stake in them. A number of popular volatility ETNs (like VXX) are known for such structure.

Prepaid forward contracts are not securities. They are taxed realizing capital gains or losses; however, Sections 1091 and 475 would likely not apply. This means wash sale adjustments would not be made on these types of ETN trades. If a trader has elected Section 475 MTM accounting, these ETN trades would not have MTM treatment. It should be noted that most prospectus documents will not address Section 1091 or 475 treatment, therefore consultation with a tax professional is advised.

TradeLog Software can identify ETNs defined in the Global Options settings for treatment as Prepaid Forward Contracts. The type/multiplier code of VTN-1 is used for classification. These trades will always be reported on the Form 8949 generated by TradeLog, and no wash sale adjustments will be made – regardless of whether an account uses MTM accounting method or not.

Options on ETNs

If you trade ETN options these may qualify for Section 1256 treatment if they are considered non-equity options. These are not reported on Form 8949, wash sale rules do not apply for these contracts, and the resulting gains/losses qualify for the beneficial 60/40 capital gains rates.

TradeLog Software can also identify ETN options that qualify for Section 1256 treatment and properly reports these like futures trades. The identifier FUT-100 is used to classify these trades. Please see the Exchange Traded / Broad-Based Index Options section to learn more.

Summary Chart for ETN Tax Treatment

Type of Trade
(TradeLog Class)
Tax Treatment Wash Sale Rules Apply? Sec. 475 MTM Eligible? TradeLog Report
ETN – Foreign Currency
(CTN-1)
Ordinary Gain/Loss
(Sec. 988)
No No Forex/Currencies
ETN – Debt Security
(ETF-1)
Capital Gain/Loss Yes Yes – with qualified election Form 8949
(Form 4797 if MTM elected)
ETN – Prepaid Forward Contract
(VTN-1)
Capital Gain/Loss No No Form 8949
ETN Option – Non-Equity
(FUT-100)
60/40 Capital Gains Rate
(Sec. 1256)
No Yes – with qualified election for futures Section 1256 Contracts

Challenges for Taxpayers

When it comes to ETNs other than those based on foreign currency, determination of tax treatment is not always very clear. Taxpayers may need to examine the ETN’s prospectus and consult with a professional tax advisor.

Broker-provided 1099-B reporting typically categorizes all types of ETNs as “securities” to be reported on Form 8949. And brokers usually make limited wash sale adjustments. The results could cause wash sale deferrals into the next tax year, which may increase tax liability – depending on the particular ETN structure this may be inaccurate. In the case of ETN options that qualify for Section 1256, the 1099-B reporting may cause a taxpayer to miss out on the beneficial 60/40 capital gains rates.

TradeLog Software Benefits

As discussed above, TradeLog can identify and properly report various types of ETN trades. As a result, traders can potentially reduce tax liability resulting from deferred wash sales and may benefit from the beneficial Section 1256 treatment of some ETN options.

Broker 1099-B reporting may not properly report ETN trades depending on their structure, as noted above. This could make it impossible to use the 1099-B alone for tax reporting. TradeLog can generate an accurate Form 8949 – and the other needed tax reports – including explanations for the IRS on the differences with 1099-B.

The Global Options settings determine treatment based on specified symbols and their classification. It’s important to note that default settings in TradeLog are based on researched opinions published by leading tax authorities but are not definitive. Remember that each taxpayer is responsible for the accuracy of their reporting. TradeLog provides the tools to help traders and investors generate the reporting they need.

TradeLog helps active traders generate accurate tax reporting.

Please note: This information is provided only as a general guide and is not to be taken as official IRS instructions. Cogenta Computing, Inc. does not make investment recommendations nor provide financial, tax or legal advice. You are solely responsible for your investment and tax reporting decisions. Please consult your tax advisor or accountant to discuss your specific situation.