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How ETFs circumvent IRS wash-sale rules

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Institutional investors are harvesting ETF losses for tax purposes, then placing their assets in highly correlated funds — regardless of so-called wash-sale restrictions, a new study found.

In theory, IRS guidelines prohibit investors from buying “substantially identical” securities 30 days before or after selling them. 

In practice, fund managers, pensions, insurance firms, endowments and other institutional investors “engage in substantial swapping” of ETFs with holdings that are 99% or more the same thing to the tune of $417 billion in assets since 2001 and $106 billion in 2022 in transactions that “seem to lack economic substance beyond harvesting capital losses,” according to a working academic paper released this summer and revised last month by four professors of business and management. The findings, which echo those of another working paper from earlier this year, shed more light on how ETFs help financial advisors and their clients offset the taxes on capital gains by booking losses in their portfolios.

“While the economic intent of the wash sale rule is straightforward, significant uncertainty remains as to the permissibility of tax deductions achieved through ETF swaps,” the report’s authors — Michael Dambra of the University of Buffalo and Andrew Glover, Charles M.C. Lee and Phillip Quinn of the University of Washington — wrote in the introduction. “Specifically, the IRS has not ruled on what constitutes a ‘substantially identical’ security, leaving financial advisors to navigate a foggy legal landscape. Some advisors seem to take the regulatory silence as tacit permission to swap ETFs that hold identical securities or that are even benchmarked to the same index (e.g., Lasser 2011). Others argue that if an investor’s economic position has not changed after swapping ETFs, the spirit of the wash sale rule has likely been violated (e.g., Fischer 2010). Against this backdrop of legal uncertainty, the extent to which investors engage in tax avoidance through ETF wash sales remains largely unknown.”

READ MORE: How a newly unified GOP government will affect ETFs

Representatives for the SEC declined to comment on the report’s conclusions and referred questions to the IRS, which didn’t provide a response.

The findings essentially “confirmed what all of us expected,” but “what was striking about the study was being able to demonstrate that the loss harvesting was material enough to be measured,” said Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, a nonpartisan think tank.

Tax strategies around possible wash sales have been “going on for decades and decades and decades,” he noted. The rise of ETFs — which topped $10 trillion in assets for the first time in September in a shift fueled by technology, lower fees and tax advantages — has altered the picture. But it’s not clear whether IRS policymakers or members of Congress will try to rein in the wash-sale practices documented in the report.

“I don’t think they view this as high on their agenda, because there’s other tax evasion that goes on. This is lawful, and the question is whether it’s pushing the limits,” Rosenthal said in an interview. “It’s just easier now. There are more vehicles, there are more opportunities, there is more technology to help plan and there are more people marketing these strategies as a result of the ease.”

The study hasn’t been published by a peer-reviewed journal, and the researchers listed some possible “sources of noise” in the data they tracked from quarterly SEC filings of firms’ holdings known as Form 13F and granular trading records from financial technology firm AbelNoser Solutions, a Trading Technologies company. Some swap trades of correlated ETFs could have occurred at random, between the quarterly filings, at lower than 99% matches in their holdings or at an even greater volume when considering the growth of ETFs, the authors wrote.

“Exchange-traded funds provide an efficient way for investors to circumvent the trading frictions associated with the wash sale rule,” Dambra and the other academics wrote. “Specifically, investors can sell a depreciated ETF security and realize a capital loss while simultaneously purchasing another ‘nearly identical’ ETF security. This form of swap trading allows investors to maintain a substantively identical economic position while harvesting a capital loss that can be used to offset realized gains and other taxable income. With an explosion in available ETFs over the past two decades, these securities have become ideal vehicles for circumventing the wash sale rule.”

READ MORE: The most wonderful time of the year, for tax-loss harvesting

Their research suggests that ETFs can offer even greater tax efficiency than many experts have pointed out in the past — or that the IRS may be ignoring the enforcement of a rule that has restricted loss harvesting maneuvers for more than a century.   

“The expansion of ETFs has provided investors with a new, low-cost tool whereby capital losses can be realized without disturbing an optimal portfolio,” the authors wrote. “Similar to the findings in Li (2024), we find the introduction of a near-identical ETF leads to more volume activity for the incumbent ETF. Next, we find that tax-sensitive institutions hold a more diverse set of highly correlated ETFs, invest a larger portion of their AUM in these ETFs, engage in more swapping between near-identical ETFs and capture more capital losses with this swapping activity. We estimate conservatively that capital loss recognition attributable to annual swapping among tax-sensitive institutional investors is in the tens of billions of dollars. While this behavior is becoming increasingly widespread and economically important, regulators have remained silent on where ETFs fit in their definition of ‘substantially identical securities.’ We contribute to the policy discussion on the potential costs of that continued silence.”

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IAASB tweaks standards on working with outside experts

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The International Auditing and Assurance Standards Board is proposing to tailor some of its standards to align with recent additions to the International Ethics Standards Board for Accountants’ International Code of Ethics for Professional Accountants when it comes to using the work of an external expert.

The proposed narrow-scope amendments involve minor changes to several IAASB standards:

  • ISA 620, Using the Work of an Auditor’s Expert;
  • ISRE 2400 (Revised), Engagements to Review Historical Financial Statements;
  • ISAE 3000 (Revised), Assurance Engagements Other than Audits or Reviews of Historical Financial Information;
  • ISRS 4400 (Revised), Agreed-upon Procedures Engagements.

The IAASB is asking for comments via a digital response template that can be found on the IAASB website by July 24, 2025.

In December 2023, the IESBA approved an exposure draft for proposed revisions to the IESBA’s Code of Ethics related to using the work of an external expert. The proposals included three new sections to the Code of Ethics, including provisions for professional accountants in public practice; professional accountants in business and sustainability assurance practitioners. The IESBA approved the provisions on using the work of an external expert at its December 2024 meeting, establishing an ethical framework to guide accountants and sustainability assurance practitioners in evaluating whether an external expert has the necessary competence, capabilities and objectivity to use their work, as well as provisions on applying the Ethics Code’s conceptual framework when using the work of an outside expert.  

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Tariffs will hit low-income Americans harder than richest, report says

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President Donald Trump’s tariffs would effectively cause a tax increase for low-income families that is more than three times higher than what wealthier Americans would pay, according to an analysis from the Institute on Taxation and Economic Policy.

The report from the progressive think tank outlined the outcomes for Americans of all backgrounds if the tariffs currently in effect remain in place next year. Those making $28,600 or less would have to spend 6.2% more of their income due to higher prices, while the richest Americans with income of at least $914,900 are expected to spend 1.7% more. Middle-income families making between $55,100 and $94,100 would pay 5% more of their earnings. 

Trump has imposed the steepest U.S. duties in more than a century, including a 145% tariff on many products from China, a 25% rate on most imports from Canada and Mexico, duties on some sectors such as steel and aluminum and a baseline 10% tariff on the rest of the country’s trading partners. He suspended higher, customized tariffs on most countries for 90 days.

Economists have warned that costs from tariff increases would ultimately be passed on to U.S. consumers. And while prices will rise for everyone, lower-income families are expected to lose a larger portion of their budgets because they tend to spend more of their earnings on goods, including food and other necessities, compared to wealthier individuals.

Food prices could rise by 2.6% in the short run due to tariffs, according to an estimate from the Yale Budget Lab. Among all goods impacted, consumers are expected to face the steepest price hikes for clothing at 64%, the report showed. 

The Yale Budget Lab projected that the tariffs would result in a loss of $4,700 a year on average for American households.

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At Schellman, AI reshapes a firm’s staffing needs

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Artificial intelligence is just getting started in the accounting world, but it is already helping firms like technology specialist Schellman do more things with fewer people, allowing the firm to scale back hiring and reduce headcount in certain areas through natural attrition. 

Schellman CEO Avani Desai said there have definitely been some shifts in headcount at the Top 100 Firm, though she stressed it was nothing dramatic, as it mostly reflects natural attrition combined with being more selective with hiring. She said the firm has already made an internal decision to not reduce headcount in force, as that just indicates they didn’t hire properly the first time. 

“It hasn’t been about reducing roles but evolving how we do work, so there wasn’t one specific date where we ‘started’ the reduction. It’s been more case by case. We’ve held back on refilling certain roles when we saw opportunities to streamline, especially with the use of new technologies like AI,” she said. 

One area where the firm has found such opportunities has been in the testing of certain cybersecurity controls, particularly within the SOC framework. The firm examined all the controls it tests on the service side and asked which ones require human judgment or deep expertise. The answer was a lot of them. But for the ones that don’t, AI algorithms have been able to significantly lighten the load. 

“[If] we don’t refill a role, it’s because the need actually has changed, or the process has improved so significantly [that] the workload is lighter or shared across the smarter system. So that’s what’s happening,” said Desai. 

Outside of client services like SOC control testing and reporting, the firm has found efficiencies in administrative functions as well as certain internal operational processes. On the latter point, Desai noted that Schellman’s engineers, including the chief information officer, have been using AI to help develop code, which means they’re not relying as much on outside expertise on the internal service delivery side of things. There are still people in the development process, but their roles are changing: They’re writing less code, and doing more reviewing of code before it gets pushed into production, saving time and creating efficiencies. 

“The best way for me to say this is, to us, this has been intentional. We paused hiring in a few areas where we saw overlaps, where technology was really working,” said Desai.

However, even in an age awash with AI, Schellman acknowledges there are certain jobs that need a human, at least for now. For example, the firm does assessments for the FedRAMP program, which is needed for cloud service providers to contract with certain government agencies. These assessments, even in the most stable of times, can be long and complex engagements, to say nothing of the less predictable nature of the current government. As such, it does not make as much sense to reduce human staff in this area. 

“The way it is right now for us to do FedRAMP engagements, it’s a very manual process. There’s a lot of back and forth between us and a third party, the government, and we don’t see a lot of overall application or technology help… We’re in the federal space and you can imagine, [with] what’s going on right now, there’s a big changing market condition for clients and their pricing pressure,” said Desai. 

As Schellman reduces staff levels in some places, it is increasing them in others. Desai said the firm is actively hiring in certain areas. In particular, it’s adding staff in technical cybersecurity (e.g., penetration testers), the aforementioned FedRAMP engagements, AI assessment (in line with recently becoming an ISO 42001 certification body) and in some client-facing roles like marketing and sales. 

“So, to me, this isn’t about doing more with less … It’s about doing more of the right things with the right people,” said Desai. 

While these moves have resulted in savings, she said that was never really the point, so whatever the firm has saved from staffing efficiencies it has reinvested in its tech stack to build its service line further. When asked for an example, she said the firm would like to focus more on penetration testing by building a SaaS tool for it. While Schellman has a proof of concept developed, she noted it would take a lot of money and time to deploy a full solution — both of which the firm now has more of because of its efficiency moves. 

“What is the ‘why’ behind these decisions? The ‘why’ for us isn’t what I think you traditionally see, which is ‘We need to get profitability high. We need to have less people do more things.’ That’s not what it is like,” said Desai. “I want to be able to focus on quality. And the only way I think I can focus on quality is if my people are not focusing on things that don’t matter … I feel like I’m in a much better place because the smart people that I’ve hired are working on the riskiest and most complicated things.”

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