Most of what SPYI pays out each month isn’t taxed the year you receive it. In 2024, roughly 94% of the NEOS S&P 500 High Income ETF’s distributions were classified as return of capital, which reduces your cost basis instead of triggering current tax.1NEOS Investments. A Look at SPYI’s 2024 Distribution Classifications The gains the fund does realize on its SPX call options qualify as Section 1256 contracts, so they receive a blended 60% long-term, 40% short-term tax treatment regardless of how briefly the fund held the position. That combination is what shapes SPYI tax treatment for individual shareholders.
Return of Capital Drives Most of Your Tax Bill
Return of capital is not taxed in the year you receive it. The IRS treats it as a return of your own investment rather than income from dividends or gains.2Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions Each payment reduces your cost basis in the fund. Buy shares at $50, receive $5 in cumulative return of capital, and your adjusted basis drops to $45. When you eventually sell, you calculate gain or loss from that lower basis, which produces a larger taxable gain or smaller deductible loss at sale.
There is a hard limit. Once return-of-capital distributions reduce your basis to zero, any additional return of capital becomes a taxable capital gain in the year you receive it.3Internal Revenue Service. Mutual Funds (Costs, Distributions, Etc.) Long-term holders collecting substantial monthly payouts need to track cumulative basis reductions. Your brokerage should adjust cost basis automatically, but verifying those figures against the fund’s annual distribution classifications is worth doing every year.
The remaining share of SPYI’s 2024 payout, about 6%, was classified as ordinary dividends. No portion was classified as long-term capital gains that year.1NEOS Investments. A Look at SPYI’s 2024 Distribution Classifications The mix can shift from year to year, so don’t assume the same split will hold.
How the 60/40 Split Works on the Fund’s Option Gains
SPYI writes call options on the S&P 500 Index. Those SPX options are cash-settled, European-style, and track a broad market index rather than a single stock, which is why they qualify as “nonequity options” under Section 1256.4NEOS Investments. SPYI Prospectus Options on individual stocks or on ETFs like SPY are equity options and don’t get this treatment.
Every gain or loss on a Section 1256 contract is automatically split into 60% long-term and 40% short-term capital gain or loss, regardless of holding period.5Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market6Internal Revenue Service. Topic No. 409, Capital Gains and Losses7Internal Revenue Service. Federal Income Tax Rates and Brackets The math:
- 60% at the 20% long-term rate: 12%
- 40% at the 37% short-term rate: 14.8%
- Combined maximum federal rate: 26.8%
For investors in lower brackets, the long-term portion can be taxed at 0% or 15% depending on total taxable income, pulling the blended figure down further.
Year-End Mark-to-Market
Section 1256 contracts come with a year-end quirk. Every open position is treated as if it were sold at fair market value on the last business day of the tax year, and any resulting gain or loss is recognized for that year even though the fund hasn’t closed the position.5Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market
For SPYI shareholders, this happens inside the fund and gets folded into the tax character of the distributions you receive. You don’t need to compute it. What it means practically: unrealized gains on the fund’s option positions can’t be deferred year to year the way gains on a stock holding can, but unrealized losses also get recognized and can offset other gains.
The 3.8% Net Investment Income Tax
The 26.8% blended ceiling isn’t the whole story for higher earners. Section 1411 imposes a 3.8% net investment income tax on capital gains, dividends, and other investment income once modified adjusted gross income crosses these thresholds:8Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
- Married filing jointly: $250,000
- Single or head of household: $200,000
- Married filing separately: $125,000
These amounts are fixed in the statute and are not indexed for inflation, so more taxpayers cross them each year. Stacked on top of the 26.8% Section 1256 ceiling, the combined maximum federal rate reaches 30.6%. That still runs meaningfully below the 40.8% that applies to short-term gains and ordinary income at the top bracket. State taxes add on top.
Carrying Section 1256 Losses Back Three Years
If you realize a net loss on Section 1256 contracts in a given year, you can elect to carry it back to offset Section 1256 gains reported in the three prior tax years. The election is made by checking Box D on Form 6781 and entering the carryback amount on line 6 of Part I.9Internal Revenue Service. Form 6781 – Gains and Losses From Section 1256 Contracts and Straddles Most capital losses can only be carried forward, so this is an unusual tool. The loss keeps its 60/40 character when carried back, offsetting prior gains in the same blended proportion.
What You’ll Receive at Tax Time
Two documents matter for SPYI, and both should arrive from your brokerage in late January or February.
Form 1099-DIV reports the distributions. Box 1a shows total ordinary dividends, Box 1b identifies the portion qualifying for lower tax rates, and Box 3 reports the amount classified as return of capital.10Internal Revenue Service. About Form 1099-DIV, Dividends and Distributions Given SPYI’s distribution profile, Box 3 will likely be the largest number on that form.
Form 6781 is where Section 1256 activity gets reported. The form applies the 60/40 split mechanically: line 8 calculates 40% as short-term, and line 9 calculates 60% as long-term, and those amounts flow to Schedule D.9Internal Revenue Service. Form 6781 – Gains and Losses From Section 1256 Contracts and Straddles Your brokerage may deliver this information on a supplemental statement or on Form 1099-B rather than a pre-filled Form 6781, so read any accompanying documentation that breaks out Section 1256 contract activity.
Keep your own running record of cumulative return-of-capital distributions. Brokerages track adjusted cost basis, but discrepancies can happen when you transfer shares between brokers or when a fund reclassifies distributions after the initial 1099-DIV has already gone out. Comparing your running basis against SPYI’s published annual classifications takes a few minutes and can prevent an unpleasant surprise the year you sell.