Moderate-Length Barrel Evangelist
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Posted: 7/31/2025 3:13:17 AM EDT
[Last Edit: 1168RGR][Edited]
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Hi, I was looking at some of the ETFs I hold, or am interested in, on dividend.com to double-check what I was seeing in the info on my brokerage. I noticed that dividend.com lists ETF dividends as ordinary instead of qualified. So, I went to the SPDR website and looked at SPYD as an example, and what I found was that less than half of the dividends are qualified. $1.46 vs $1.86. Before I go down the rabbithole of checking tax info on hundreds of individual stocks that make up these ETFs, I thought I’d ask here. Would I expect to find the same ratio of ordinary vs qualified taxation in the underlying stocks, or does being in the ETF basket cause some qualified dividends to become ordinary income, perhaps through fund rebalancing or the way they’re distributed? I’m only interested in understanding the ordinary vs qualified tax categories, not discussing growth vs dividends. |
| It’s a good question. I don’t have a good answer, though I suspect you might be right about re-balancing, at least for part of it. Another small part is that they loan shares to shorts. The money that shorts pay for dividends is taxed as regular income not qualified dividends. |
Moderate-Length Barrel Evangelist
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Originally Posted By grendelbane: It’s a good question. I don’t have a good answer, though I suspect you might be right about re-balancing, at least for part of it. Another small part is that they loan shares to shorts. The money that shorts pay for dividends is taxed as regular income not qualified dividends. That’s a good point, and is why I have stock lending turned off in my brokerage. If a fund manager does stock lending invisibly to me, that could make the difference on tax day that I’m wondering about. Did some quick napkin math. SPYD is “equal” weighted and contains 80 stocks. The top 10 holdings make up 15.66% of the fund. 9/10 of those in 2024 distributed only qualified dividends, and the remaining one distributed only un-qualified dividends. Looking at one share of each, without attempting to equalize weights, that would be $6.26 un-qualified and $20.26 qualified. So, ~3/4 qualified. Glancing at share prices, assigning them each equal weight would further reduce the ratio taxed as ordinary income in that sample. Something like ~4/5 qualified. I wonder if that extrapolates to the other 70 stocks in that basket. If so, then SPYD works at a significant tax disadvantage in comparison to buying the 80 underlying stocks with equal portfolio weight, and holding them for a year or more between rebalancings. |
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Originally Posted By 1168RGR: Would I expect to find the same ratio of ordinary vs qualified taxation in the underlying stocks, or does being in the ETF basket cause some qualified dividends to become ordinary income, perhaps through fund rebalancing or the way they’re distributed? I’m only interested in understanding the ordinary vs qualified tax categories, not discussing growth vs dividends. How dividends are treated by any fund varies wildly based on how the fund is managed. The dividends paid by any individual stock the fund holds has no direct correlation to the type of dividends the fund pays. There are some funds where the treatment of dividends is not even known until the calendar year is done and the fund determines what fraction of dividends are qualified retroactively. As an extreme example, many of the ultra-high dividend funds tout the fact that their dividends are "95% tax-free" or similar. The reason for this is that their dividends are simply returning your principal. ie. if you invest $100 and they pay you $5 in dividends out of your principal that $5 was already yours and thus it is tax free. One thing I've learned over the last few years is that people often spend an inordinate amount of time worrying about the tax treatment of investments. If you have to pay taxes that means you are making a profit and that it a good problem to have. I'm not saying to ignore taxes, but be reasonable. If your investment strategy is meeting your goals I would not change it only for the purpose of avoiding a few dollars in taxes. Originally Posted By 1168RGR: If so, then SPYD works at a significant tax disadvantage in comparison to buying the 80 underlying stocks with equal portfolio weight, and holding them for a year or more between rebalancings. A fund is always less advantageous than DIY if you pay an expense ratio. |
Moderate-Length Barrel Evangelist
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No, it’s not a good idea to make decisions on tax treatment alone, and I wouldn’t avoid making money just to avoid taxes. The difference in the two extremes of taxation possible from a dividend is roughly half the amount of SPYD’s expense ratio, in total dollars spent vs gained. Which isn’t a terrible E/R, so we’re not talking about big numbers. With the amount I have in SPYD, the difference amounts to less than $10/year. Of course, we’re talking about less than $100/year in dividends…around $200/year total before taxes and E/R. Even further, most of the ETFs I anchor my portfolio with produce 2% or less dividends (vs SPYD’s ~4%), so it really is a very small difference which portion of their dividends are qualified or non-qualified. Probably negligible, as far as choosing which to buy. However, the relevance is that a dividend is a mandatory taxable event repeated throughout the life of a position held long term. So, it’s nice when they are treated as qualified/long term capital gains to minimize that tax drag. Just like if I were choosing among market cap weighted S&P 500 index ETFs, I’d choose the one with the smallest E/R. Because if the added expense is all but guaranteed to not gain me anything, the 0.04% or whatever difference in expenses is wasted pennies. Upon further analysis, 18 of the 80 holdings in SPYD produce non-qualified dividends. All 18 are REITs. Unsurprisingly, those are among the highest yielding (though worst growing; imagine that) in that basket of holdings. If I had to swing a wild ass guess, 35%-40% of dividends in the equal-weighted fund are non-qualified if held DIY, roughly inverse of the ~60/40 split that investors in the ETF see. As a side-note, I’m a little surprised how many of these holdings have lost investors’ money over the last decade. For anyone just scanning the internet for ticker symbols, please understand that SPYD is being used here as an academic example to accentuate tax implications of dividends in an ETF (that I didn’t expect to see so many REITs in). Not because I expect to see it outperform other ETFs. |