Covered call ETFs have become popular for generating monthly income, but they come with complex tax implications that investors often overlook. These funds typically hold equities and sell call options to create income, but the distributions can include dividends, capital gains, and non-dividend distributions, which complicate tax reporting.
Investors may receive a 1099-DIV that reveals taxable amounts, leading to potential surprises at tax time. Matthew Smart, chief investment officer at WWM Investments, warns that the after-tax net total return could be lower than expected.
The mix of distributions varies by fund, and non-dividend distributions, known as return of capital (ROC), can reduce the cost basis, deferring taxes until shares are sold. Financial advisors recommend purchasing these ETFs within tax-deferred accounts like IRAs to avoid immediate tax liabilities.
The tax-cost ratio is a useful metric for assessing how taxes affect returns, with specific funds like the JPMorgan Equity Premium Income ETF (JEPI) and JPMorgan Nasdaq Equity Premium Income ETF (JEPQ) showing significant tax costs.
Additionally, investors should consider the net asset value (NAV) growth relative to distribution rates and explore alternative income-generating investments, such as bonds, which may offer better tax efficiency and lower costs compared to covered call ETFs