An exchange-traded fund (ETF) is a combination of different assets combined into one investment. Instead of having to purchase multiple single assets to achieve diversification, ETFs allow investors to achieve it with one investment. While most ETFs generally consist of different stocks, some ETFs focus on precious metals like gold and silver.
If you're an investor in an ETF containing gold or silver, here's what you should know about capital gains tax to ensure you're not surprised when you receive your tax bill.
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How U.S. income taxes work
The U.S. uses a progressive tax system, meaning the more you earn, the more you'll pay in taxes. For single filers in 2022, here are the tax brackets:
| Income Range | Tax Percentage |
|---|---|
| $0 to $10,275 | 10% |
| $10,275 to $41,775 | 12% |
| $41,775 to $89,075 | 22% |
| $89,075 to $170,050 | 24% |
| $170,050 to $215,950 | 32% |
| $215,950 to $539,900 | 35% |
| $539,900 or more | 37% |
Data source: IRS
While income ranges determine your tax bracket, the percentage associated with your tax bracket isn't exactly what you'll pay on your total income -- each range will be taxed at its respective percentage. For example, let's assume you make $80,000 annually. The amount falls into the 22% tax bracket, but you won't pay 22% on all $80,000. Instead, here's how your taxes will be calculated:
- The first $10,275 will be taxed at 10%: $10,275 * 10% = $1,027.50
- $10,276 through $41,775 will be taxed at 12%: $31,499 * 12% = $3,779.88
- $41,776 through $80,000 will be taxed at 22%: $38,224 * 22% = $8,409.29
So, instead of paying $17,600 in taxes ($80,000 * 22%), you'll owe $13,216.
How long-term capital gains taxes work
In comparison to regular income taxes, long-term capital gains are taxed more favorably. While regular income can fall into one of seven brackets, there are three primary long-term capital gains tax brackets. For single filers, the brackets are:
| Income Range | Long-Term Capital Gains Tax Rate |
|---|---|
| $0 to $40,400 | 0% |
| $40,401 to $445,850 | 15% |
| $445,851 or more | 20% |
Data source: IRS
Let's imagine you make $80,000 annually. If you were to buy 10 shares of a company at $100 and after owning them for longer than a year, you sell those shares for $120, you'd owe 15% capital gains taxes on the $200 in profit you made instead of 22%. Hold them a year or less before selling, and you'd pay ordinary income tax rates on the short-term capital gains.
However, there are three types of assets that face a modified long-term capital gains tax: small business stock, property under Section 1250, and assets deemed collectibles.
Capital gains on collectibles
Long-term capital gains on collectibles, including items such as precious metals, art, coins, stamps, and precious metals, are taxed at a higher maximum 28% rate. Although gold- or silver-backed ETFs are technically funds you can buy like other ETFs or stocks, because they're backed by precious metals, they're typically taxed at the higher collectibles rate instead of your typical long-term capital gains tax rate.
During a time when people may be considering going to alternative assets to protect themselves from market uncertainty, it's important to know the difference in tax rates so you're aware of a potential tax bill or why your profits may be smaller than anticipated.
