MoFo Tax Talk

Exchange Traded Notes—A Tax-Favored Investment Vehicle?

Exchange traded funds ("ETFs") are investment funds whose shares trade on a stock exchange. From a U.S. federal income tax standpoint, ETFs are flow-through vehicles that generally must distribute their income currently. Taxable U.S. investors include these amounts in their income annually. Viewed as economic cousins of ETFs, exchange traded notes ("ETNs") are structured notes representing securities issued by corporations, typically financial institutions. ETNs generally do not distribute income currently. Contrary to the current inclusion and ordinary income regime applicable to ETFs, ETNs are treated as prepaid forward contracts for U.S. federal income tax purposes. As such, under current law, investors in ETNs generally do not report current accruals of income and gain or loss is determined only upon a sale of the note. The following chart