Payment in lieu is taxing you
Securities lending might mean paying more tax.
Most major brokerages lend securities to short-sellers. The lender could be an ETF or individual investor. Securities lending is big business.
The short-seller/borrower owes any dividends received to the lender.
But a borrower can’t make a dividend payment, let alone a qualified dividend payment. So, they send cash, otherwise known as a “payment in lieu” (PIL) of a dividend.
The lender receives the PIL and, with it, an ordinary tax liability.
Most dividends on US stocks are qualified, so if the lender had not lent, they would have received qualified dividends, which are taxed at lower, long-term capital gains rates.
Some managers will pull back shares before the dividend ex-date so their dividends remain qualified.
Does revenue from securities lending outweigh a bigger dividend tax liability?
ETFs are required to report on securities lending activity, so a while back, I created a little spreadsheet and confirmed that securities lending was a net positive thing for investors in the one fund I analyzed.
It would be interesting to do that analysis across all ETFs.
I’d like to know about cases where tax cost outweighs lending revenue. And if there are any surprising sources of lending revenue beyond those holding lots of hard-to-borrow names.
Pat Cleary over at ETF Architect wrote about something very similar earlier today.
Jokes from the taxable wealth world…
Arbitrage alert: buy singles, return pairs.
