By
David
Hunkar
:
Currently, the top U.S. tax rate on qualified dividends is 15%.
This rate applies to taxpayers who are in the 25% to 35% tax
brackets. This means that hypothetically an ordinary American in
the 25% tax bracket having an earned income of $50,000 and getting
$1,000 in qualified dividends pays $150 in dividend taxes. A
multi-millionaire in the highest tax bracket of 35%, having an
earned income of $120.0 million and getting the same $1,000 in
qualified dividends, also pays $150 in dividend taxes. Qualified
dividends are dividends earned from stocks held for more than one
year. This low dividend tax rate is set to expire on December 31,
2012 unless Congress extends the current tax rates.
The Wall Street Journal's Jason Zweig discussed this issue in an
article last month. From
Dividends: Start Screaming
:
At one second after midnight on January 1, 2013, the maximum
tax rate on dividends is likely to go from 15% to either 18.8% or
43.4%. The best-case scenario: Congress retains the top
dividend-income tax rate of 15%, and the only increase is the
scheduled 3.8% surtax on investment income for high earners. The
worst case: Congress decides dividends are to be taxed at
ordinary-income rates, and the highest rate jumps to 39.6%, plus
the same 3.8% surtax.
The payout ratio for U.S. companies is near the all-time low of
34%. Here is another interesting quote mentioned in the
article:
C.J. MacDonald, a portfolio manager at Westwood Holdings, an
investment firm in Dallas, points out that companies paid out
roughly 60% of their earnings as dividends in 1960- even though
the tax rate on dividends topped out then at a confiscatory
91%.
So U.S. firms paid out a larger portion of their earnings even
when the top dividend tax rate stood at 91% compared to the low
rate now. And they did not withhold profits due to the higher taxes
for shareholders.
What will be the impact of a higher tax rate on dividends
for dividend-paying stocks?
The investment advisory firm of Miller/Howard Investments, Inc.
has published a
white paper
analyzing the answer to the above question. The paper states that
it will not matter for investors in dividend stocks if the tax
regime changes.
The research paper referenced a Federal Reserve study where the
authors analyzed the effect of tax changes using U.S. stock market
vs. European markets, U.S. stock market vs. REITs (as the tax cut
did not benefit income from REITs), and high-yield dividend stocks
(3% yield and greater) vs. low-yield stocks and non-dividend
payers.
Their conclusions were:
-
There was little if any imprint of the dividend tax cut
on the value of the aggregate stock market.
-
High-yield stocks did receive a boost but the effects
were short-lived.
-
REITs dropped on the day before bill was signed but
recovered within days.
-
A substantial portion of U.S. stocks were held in
accounts or entities for which the lower dividend tax rate
did not apply.
Similar to the top dividend tax rate at 15%, the top long-term
capital gains tax rate is also 15% for investors in the 25% or
higher tax-brackets. Long-term capital gains apply to gains from
assets held for over one year.
How did dividend-paying stocks perform when the capital
gains tax rate and dividend tax rates were different?
The following chart from Ned Davis Research comparing the
performance of dividend-payers and non-dividend payers over
different tax regimes in the past offers the answer:
(click to enlarge)
(click to enlarge)
via Ned Davis Research
The chart shows that there was no impact on the performance of
dividend-paying stocks even with a beneficial capital gains tax
rate over a dividend tax rate.
Source:
A dividend tax hike? What does it mean for dividend-paying
stocks?
, Miller/Howard Investments, Inc.
I agree that any tax changes on dividends after December 31,
2012 will not affect the performance of dividend stocks. Even
though there may be a slight impact in the short term, prices
should recover quickly. Another factor that must be considered is
that most of the stocks are held in non-taxable retirement accounts
such as 401((
K
)), IRAs etc. where earnings grow tax-free until withdrawn. Hence
in summary, dividend investors need not worry too much about any
tax law changes. Instead of wondering about what Congress might do,
investors can take advantage of the current lower dividend stock
prices and add to their portfolios now through the rest of the
year.
Related
ETFs
:
-
iShares Dow Jones Select Dividend ETF (
DVY
)
-
SPDR S&P Dividend ETF (
SDY
)
-
Vanguard Dividend Appreciation ETF (
VIG
)
-
Vanguard High Dividend Yield ETF (
VYM
)
Disclosure:
No positions
See also
What Green Mountain Roasters Earnings Results Means
For Sodastream
on seekingalpha.com