IRS Targets Crypto ETFs Over Tax Compliance Issues

The IRS has issued a notice regarding crypto ETFs (exchange-traded funds) that utilize trading strategies to avoid reporting gains. This follows the IRS's shutdown of a tax-free stock swap used by wealthy investors, both actions addressing the same ETF tax rule. Most US funds benefit from a special tax status, avoiding taxes if at least 90% of their income comes from dividends, interest, and stock gains. However, profits from crypto and commodities do not qualify, risking this tax break. The IRS claims some ETFs circumvent this by transferring rising digital assets to Wall Street firms, allowing them to cash in fund shares without booking a taxable gain. The notice does not specify which funds are affected, but it highlights risks for regular funds holding crypto or shares of trusts. Funds using offshore subsidiaries are exempt. The IRS indicated that any future guidance could apply retroactively to past transactions. Additionally, the IRS has eliminated the Section 351 conversion, which allowed wealthy investors to trade stock for diversified funds without tax implications, now classifying such transactions as taxable sales. The Investment Company Institute has expressed concerns that these changes could impact diversification and fees.

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