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My understanding that when you purchase an ETF, you technically own your portion of the underlying holdings. (This is the reason commodity ETFs are taxed like commodities.)

Per the below an ETF may collect a cash dividend and reinvest into it's holdings rather than paying out to the investor. Are these dividend reinvestments taxable like normal dividend reinvestments? And why?

  1. Do ETFs always pay out the full dividend of all its constituent stocks? Yes, ETFs always collect the full dividend of all constituent stocks and always 'pay out' the dividends to the ETF shareholder. This can be a cash distribution or a reinvestment in the ETFs' underlying index. It comes to the same, because if your ETF reinvests and you need the 2%-3% annual cash stream you can just sell 2%-3% of your annual ETF position to obtain the cash. http://www.nasdaq.com/investing/etfs/etf-faqs.aspx#n3#ixzz2YBrcOT18

This is for nonqualified accounts.

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Yes, these are taxable events because the ETF isn't paying the taxes on the dividends which would taxed at a corporate rate which isn't what most people would want I believe. Though there is a bit more to the picture looking from About.com:

As you know, one of the main benefits of ETFs is the tax advantage it holds over mutual funds. However, when it comes to paying taxes on ETF dividends, the story is a little different.

Qualified ETF Dividends

There are two kinds of dividends that the stocks in an ETF may issue. Qualified dividends and unqualified dividends. In order for an ETF dividend to be taxed as qualified, the equity in the fund paying the dividend must be owned by the investor for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. Also, it cannot be on the unqualified dividend list and it must be paid by a U.S. or qualified foreign corporation.

The tax rate on qualified dividends is anywhere from 5% to 15%, depending on your income tax rate. If you have an income tax rate of 25% or higher, then your qualified dividend is taxed at 15%. If your income tax rate is less than 25%, then your qualified dividends are taxed at 5% So far, so good.

Unqualified ETF Dividends

Unqualified dividends are those payouts that do not meet the qualifications discussed above. In other words, they are dividends that the government does not consider true dividends. Some examples include dividends on money market accounts, dividends on short term mutual fund capital gains, interest from your credit union, dividends in your IRA, and dividends from REITs (real estate investment trusts). In the case of unqualified dividends, these payouts are taxed at your normal income tax rate. So if you have unqualified dividends from the ETFs in your portfolio, then they will have a heavier tax burden than the normal qualified dividends from these securities.

Keeping track of your Dividends

Knowing the difference between qualified and unqualified dividends is very important in regard to ETFs. After you understand the concept, you will need to put that knowledge to use as you track the dividend payouts for all the stocks in your dividend ETFs (a spreadsheet may be helpful). Once you have it all figured out, you can fill out your tax forms correctly and file your return. Or you can do what most investors do and hire a good tax accountant. Hopefully your gains will cover his fee.

Hopefully that helps answer the question.


Generally, the fund will keep track over each quarter and make the distribution amongst the shares in the proper amount for the dividends it held. Initially, the "Unit Investment Trust" strategy used by the SPDRs of old, there wasn't any buying or selling within the trust and creation/redemption units would have to be done to change the portfolio. That has changed more recently and I'm not totally sure what mechanisms are now used though I do believe there isn't that much buying and selling within the fund as that would trigger capital gains which can be avoided through the creation/redemption mechanism within an ETF.


Don't forget that the quote you give doesn't state that there aren't additional shares of the ETF being purchased with the distribution and that would be a taxable transaction. While the broker may not charge to re-invest the distribution, the giving it out is taxable as this happens with mutual funds.

  • Could you go into detail? Or provide a source? Taking out the boilerplate tax-sheltered account information, this answer pretty much just says 'Yes' – user606723 Jul 5 '13 at 17:14
  • I've added details to my question. I'm sorry, I thought it was quite obvious that I am referring to taxable accounts otherwise the question is meaningless. I also added "And Why?" That would be the extra detail I am looking for. WHy are these taxable events? Could you provide a source to why these are taxable events. – user606723 Jul 5 '13 at 17:33
  • The article dicusses "unqualified dividends from the ETFs", However, I am not talking about dividends from the ETF. I am talking about the dividends of the underlying stock which is reinvested by the fund itself. The article doesn't cover that. – user606723 Jul 5 '13 at 17:45
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    And if these dividends are taxed. The ones that are autoreinvested by the ETF (Not by your broker.) How do you keep track of these? – user606723 Jul 5 '13 at 17:47
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    There's some confusion here. It's the broker who would reinvest the dividends for you. The ETF isn't going to send you a 1099 without having distributed the dividend. It's your choice to reinvest. – JoeTaxpayer Jul 5 '13 at 18:23
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Most ETFs are required to pay out all dividends collected to holders of the fund. However, per the below, there are some ETFs that have been granted permission to reinvest the dividends collected into the fund's underlying holdings. In either case, these are taxed very much the same.

For information about whether a ETF distributes or reinvests the collected dividends, please see the prospectus of the respective fund.

Some ETFs, however, have been granted permission by the SEC to reinvest the proceeds from dividends in ETF holders' accounts. (Costs of running an ETF are subtracted from dividends to be paid to ETF holders at least annually.) Dividends received or reinvested are taxed as personal income to the ETF unit holders. In the case of ETFs that realize a capital gain, the gain is passed onto the holders of the ETF funds, and also taxed as personal income. http://www.investopedia.com/ask/answers/05/etfdistributions.asp

  • Fair enough, they make a vague reference to what you suggest, but no example of a specific ETF. – JoeTaxpayer Jul 5 '13 at 23:21

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