Here’s a little something to keep in mind as you try to figure out how you are going to pay that tax bill that comes due next Monday.  (Today is the 8th of April, right?)

Did you ever consider tracking what different traders do each day?
Most of the time, it’s boring. They are all just trying to make a buck.
But, every once in a while, you can stumble on something that makes you wonder. Or get highly incensed.

Like someone dumping $ 3 billion into a State Street Corporation tech fund. But that small, tidy sum is only parked there  for a total of two days. Oh wait, there’s more. This sum of bucks was some 4 or 5 times the largest transaction the fund ever received before.  (By now, you’ve recognized that this is not a hypothetical.)

You see it’s another tax dodge by “asset managers” and “investment banks”. And, theoretically, asset managers are supposed to diversify their clients’ funds, to mitigate the risk that exists in all trades.

And, this little trick has become such a frequent occurrence, it even has a nickname. “Heartbeat”. And, they permeate the entire ETF market. (There were 500 heartbeats last year alone. Not quite the number of heartbeats each of us has in a year- thankfully- because there are about 40 million of them.)

First, we need to explain what an ETF is. It’s like a mutual fund, but trades as if it were stock in a company. Even though it could be a stock index (like the Standard & Poor’s), a bond fund, or other similar items.

Secondly, we have to understand that most ETF’s have specific days over the course of the year that they “correct” themselves. What that really means is that they adjust their holdings to erase any capital gains they may have. And, that gains means one should owe the government some taxes.

Additionally,  we need to know that the new tax law (Tax Cut and Jobs Act, 2017) didn’t erase this little quirk that has existed for more than 50 years. (26 U.S. Code § 852.Taxation of regulated investment companies and their shareholders.)

But, when this 1969 law was written, Congress did not regard it as a “gimme”. Mutual funds didn’t get involved in the program, since investors were only interested in cash back then.Sentiments stayed that way for about 25 years, until the American Stock Exchange realized what a blessing this little section of the tax code could be.

Which explains why a bunch of asset managers are buying these ETF’s. Or not. The fund “invests” its capital gains in an ETF that needs to replace a withdrawing fund investor. And, what happens when no one is really withdrawing a cash from the fund? That’s where a friendly bank comes into play. But, creating extra withdrawals from the fund by rapidly pumping assets in and out of the fund.

What’s critical about covering a withdrawal from the fund? Because now, instead of owing the IRS a tax on the capital gains, by investing in a fund that is suffering a withdrawal (or one manipulated by the banks), no taxes are due.

Oops, there goes a heartbeat– one that hides significant capital gain from the taxman. But, that would also require the IRS to be tracking these transactions.

Imagine if a computer store were paid a commission on every hard drive it sold. Regardless if they got returned. And that computer store arranged for 15 folks to buy a hard drive every hour- and promptly return them. Since there was no penalty for the return, the computer store really cleans up on those commissions.

That’s pretty much what the banks are doing for the asset managers. Folks with names you know well- BlackRock, State Street, Vanguard. Getting their help from their bankers like Credit Suisse, BankAmerica, and GoldmanSachs.

Here’s the real problem. It’s not just heartbeats that happen four or five times a year for these funds. ETF’s pretty much operate this way every day of the year. Since ETF’s are not the currency of the average investor (it’s banks and brokerage houses that buy and sell these assets)- and the banks simply add or delete stocks from the portfolio, instead of placing or withdrawing cash. (The banks and brokers call this creating or redeeming ETF shares.)

How much money are we talking about? How about almost $ 65 billion- that’s just the take for the State Street Bank. Or, almost $ 60 billion for BlackRock. Or, more than $ 55 billion for Vanguard. Converting capital gains into tax-free heartbeats. All told, more than $ 210 billion in gains were sheltered this way last year alone! (Just so you know- that means the Treasury was shorted at least $ 25 billion last year.)

Ain’t it grand to be rich?

Maybe now you understand why Bernie Sanders and Kirsten Gillibrand want to re-impose at 0.5% tax on stock trades (and 0.1% on bond sales)….