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Section 351 conversion ETFs promote investment tax strategy

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Clients with diversified yet heavily appreciated stocks could more effectively defer capital gains and avoid the tax hit of dividends by converting them into a newly burgeoning type of ETF.

Transferring the varied holdings into an ETF with a similar basket of investments based on the rules of Section 351 of the Internal Revenue Code enables what is known as an “in-kind” exchange of assets. The approach has existed for nearly a century, but a raft of new ETFs — starting with the launch last month of the Cambria Tax Aware ETF (ticker: TAX) — reflect how financial technology is applying it on a mass scale, according to Mebane “Meb” Faber, co-founder and chief investment officer of Cambria Investment Management. The quantitative management and alternative investments firm collaborated with ETF tax and operational advisory firm ETF Architect on the Dec. 18 start of TAX.

READ MORE: IRS silence allows investors to exploit ETF loophole, study finds

Appreciated stock portfolios — especially those using increasingly popular forms of direct indexing — can often get “stuck” in limbo with their rising values and the potential for realizing taxable capital gains, Faber said. Financial advisors could think of the Section 351 transfer as a 1031 like-kind exchange that is for stocks rather than other kinds of assets. Even though the tax law provision has existed for a long time, some “99.9% of people” that Cambria spoke with in several hundreds of calls last quarter hadn’t heard of Section 351 transfers, according to Faber. The Securities and Exchange Commission’s 2020 ETF Rule cleared the way for software and other technology powering new products that focus on the tax impact of asset location.

“These are all ideas and strategies that are going to get developed more over the next five years,” Faber said. “You’re going to see an enormous amount of interest in this in the next six months as people kind of get it and shift.”

‘Kind of a big deal’: How Section 351 ETFs work

The TAX ETF and other funds coming to market soon represent “a very investor-friendly trend” toward returns with less risk at a lower cost, according Brent Sullivan, a consultant on taxable investing product marketing and development to sub-advisory and ETF firms. Sullivan writes the Tax Alpha Insider blog, where he’s tracking a half dozen new or pending funds from Cambria and three other sponsors pitching the Section 351 transfer strategy. Sullivan has been following the launch of TAX closely for several months, and he wrote in a “28 Days Later” dispatch earlier this month with samples from his upcoming “memezine” explaining Section 351 conversions to advisors. (“I hate white papers,” Sullivan wrote. “They feel like homework. So, I wrote and illustrated an adviser’s guide to seeding ETFs in-kind using some words, but mostly memes.”)

READ MORE: The 10 best- and worst-performing ETFs of 2024

Section 351 exchanges revolve around the idea of moving “disaggregated assets into an aggregated fund that can achieve lower cost and also better tax deferral” without booking any capital gains, he said. They could be beneficial to, for example, clients in “separately managed accounts that are way above cost basis so they can’t do tax loss-harvesting anymore,” according to Sullivan. In effect, stock assets in a status informally known as “locked” due to their potential tax burdens flow into a diversified ETF.     

“It removes tax friction from the reallocation decision. It makes assets less sticky, and, in general, that’s good,” Sullivan said. “It’s kind of a big deal, and advisors are the ones who are going to be needing to vet these products, because oftentimes they don’t come with a track record.”

Just over a month after its inception, the TAX ETF has attracted $32.5 million of net assets. It carries an expense ratio of 0.49% and the requirements that no single positions in an incoming portfolio comprise more than 25% of the holdings and any that are over 5% add up to less than 50%. Cambria intends to open two more funds that use Section 351 conversions this year, with an ETF using the ticker “ENDW” that “tracks an endowment-style allocation” across global holdings at the end of the first quarter and another targeting global equities at the end of the second, according to Faber. Advisors have likely grown familiar with the fact that mutual funds are converting to ETFs, he noted. Section 351 transfers could drive more assets to ETFs.  

“We knew there was going to be some demand for this idea and topic, and it was 10 times what we expected,” Faber said. “If you’re a taxable investor, particularly a high-tax investor, the last thing you want is dividends, because you’re paying taxes on those every year.”

READ MORE: 10 key investment strategy stories of 2024

The new ETFs are giving more advisors and their clients the opportunity to use a tactic that was previously only available to the wealthiest households, according to Sullivan.

“Meb is doing this all out in the open,” Sullivan said. “Normally this is only offered to family offices and in really one-on-one, behind-the-scenes sales. The public appeal is specifically what’s new about this moment.”

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Accounting

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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