Last year, a record $263 billion flowed into exchange- traded products (ETP), including exchangetraded funds (ETF). But not all ETPs are created equal, especially when it comes to taxes. Below we summarize the tax consequences for each type of product.

Equity & Bond ETFs. Regardless of whether they’re structured as unit investment trusts (UIT) or open-ended funds, ETFs that invest in stocks or bonds are taxed the same. Sell for a profit after a year, and you’re taxed according to the long-term capital gains rate (15 percent or 20 percent). If you sell after holding for less than a year, gains are considered short-term and taxed as ordinary income.

Annual distributions: Most equity ETFs (those not set up as UITs) usually reinvest the dividends, so you’re not taxed on these annually. But UIT-type ETFs, which have a fixed number of shares and closely track an index, must pay out dividends annually. Such dividends are either qualified (taxed at 15 percent or 20 percent) or nonqualified (taxed as ordinary income).

Don’t be confused by distributions from bond ETFs. This is interest and taxed as ordinary income, even though some Form 1099s refer to it as dividends.

Complex Structures

Grantor Trusts. ETFs that actually hold gold, silver and other commodities are usually set up as grantor trusts and taxed at the same rate as collectibles: 28 percent on long-term gains. If held less than year, then gains are taxed as ordinary income. An example is recommended ETF iShares Gold Trust (NYSE: IAU); see “Now vs. Then” on page 10.

Grantor trusts that use futures contracts are in a separate category. An example is ETF recommendation PowerShares DB Commodity Index Tracking Fund (NYSE: DBC). Taxes are due annually, based on a blended rate: 60 percent of gains are taxed at the longterm rate of 15 percent to 20 percent, and 40 percent of the gains are taxed at your ordinary income rate. At year-end, investors are sent a Schedule K-1, instead of the more familiar Form 1099.

To avoid higher taxes, many investors put Grantor Trust ETFs in tax-advantaged accounts, such as IRAs.

Master Limited Partnership ETFs & ETNs. If a master limited partnership (MLP) is held by an ETF or an ETN, investors are not necessarily getting the preferential tax treatment of an individual MLP.

In MLP ETNs, investors are treated as owning a debt instrument. So the income is taxed as ordinary income rather than as qualified dividends or partnership distributions.

MLP ETFs are considered corporations for tax purposes, and are therefore subject to double taxation—corporate and state income taxes are paid by the MLP ETF, and then a capital gains tax is paid by investors. In some cases, distributions from these types of funds are classified as a return of capital, which is usually not immediately taxable and serves to reduce the cost basis of your shares by the amount of the distribution. As a result, these distributions typically aren’t taxable until your cost basis has reached zero.

This is just a general roundup, so be sure to consult your tax advisor regarding your own specific situation.