Unlocking Tax-Efficient Income in the Russell 2000 with IWMI

In a market where tax efficiency can make or break after-tax returns, the NEOS Russell 2000 High Income ETF (IWMI) has emerged as a standout solution for income-focused investors. By leveraging a data-driven options-based strategy, IWMI not only generates high monthly income but also structures its distributions to minimize tax drag—a critical advantage in today's high-tax environment. With its recent $0.5617 per share dividend and a return of capital (ROC) framework, IWMI offers a compelling alternative to traditional small-cap income vehicles like high-yield bonds, REITs, and dividend-centric ETFs.

The Tax-Efficient Engine: Options and Section 1256 Contracts

IWMI's core strategy revolves around selling covered calls and call spreads on the Russell 2000 Index (RUT), which qualifies as Section 1256 contracts under IRS rules. These contracts are taxed at a blended rate of 60% long-term and 40% short-term capital gains, regardless of the holding period. This is a stark contrast to traditional income sources, such as REIT dividends or high-yield bond interest, which are often taxed at ordinary income rates (up to 37% in 2025). For investors in high tax brackets, this structure can significantly enhance after-tax returns.

For example, IWMI's recent $0.5617 per share dividend, declared on August 19, 2025, and payable on August 22, 2025, was classified as 100% return of capital. While ROC distributions are not taxed as income in the year received, they reduce the investor's cost basis in the fund. This defers capital gains taxation until the investor sells the shares, potentially allowing for a more favorable long-term capital gains rate (20%) in the future.

Active Management and Tax-Loss Harvesting

IWMI's active management approach further amplifies its tax efficiency. Portfolio managers dynamically adjust call options to optimize income generation while mitigating downside risk. Additionally, the fund engages in tax-loss harvesting on both its equity holdings (primarily the Vanguard Russell 2000 ETF, VTWO) and its options positions. This proactive strategy allows IWMI to offset gains with realized losses, reducing the overall tax burden for shareholders.

In contrast, traditional small-cap income vehicles often lack such structured tax management. Dividend-focused ETFs, for instance, distribute ordinary income or non-qualified dividends, which are taxed at higher rates. REITs, while offering high yields, face similar challenges, with portions of their distributions taxed as ordinary income. High-yield bonds, meanwhile, are subject to interest income taxation at marginal rates, leaving investors with less flexibility to manage tax liabilities.

Performance and Income Consistency

IWMI's strategy has delivered strong results. As of June 30, 2025, the fund reported a 5.41% one-year market return and a 6.21% annualized return since inception, outperforming the Russell 2000 BuyWrite Monthly Index. Its distribution rate of 14.90% (annualized) is particularly compelling in a low-yield environment, where 10-year Treasury yields hover near 4.25%.

The fund's income consistency is bolstered by its active options strategy. By selling call spreads, IWMI captures premium income while retaining some upside participation in rising markets. This contrasts with traditional income vehicles, which may see yields fluctuate based on credit spreads or real estate market conditions. For instance, high-yield bonds can experience volatility during economic downturns, while REITs may face pressure from interest rate hikes. IWMI's diversified approach across 2,000 small-cap companies also reduces sector-specific risks.

A Strategic Edge for Tax-Conscious Investors

IWMI's competitive advantages extend beyond tax efficiency. Its 0.68% expense ratio is lower than many traditional small-cap income funds, and its active management allows for tactical adjustments to market conditions. For investors seeking to balance income generation with capital preservation, IWMI's blend of options strategies, ROC distributions, and tax-loss harvesting offers a unique value proposition.

However, it's important to note that IWMI's income is not guaranteed and may vary with market conditions. The fund's performance is tied to the Russell 2000's volatility, and while its options strategies aim to mitigate downside risk, small-cap equities remain inherently more volatile than large-cap or bond-based alternatives.

Conclusion: A Tax-Efficient Alternative for Income Seekers

For investors prioritizing after-tax returns, IWMI represents a compelling alternative to traditional small-cap income vehicles. Its use of Section 1256 contracts, ROC structure, and active tax-loss harvesting creates a framework where income generation and tax efficiency coexist. The recent $0.5617 dividend, fully classified as return of capital, exemplifies how IWMI leverages its strategy to deliver high yields without immediate tax consequences.

In a landscape where tax optimization is paramount, IWMI's innovative approach positions it as a smart choice for those seeking to unlock tax-efficient income in the small-cap Russell 2000 universe. As always, investors should consult with a tax advisor to understand the implications of ROC distributions and Section 1256 contracts within their individual portfolios.