Never has there been
more uncertainty about taxes
than there is today. With taxes of all sorts and sizes slated to
rise in less than four months, some investors seem to be on the
verge of panic about how to respond to whatever the future may
bring. But a more measured approach to adjusting your portfolio for
possible tax hikes will serve you much better than just reflexively
making major changes to your entire investment strategy.
Lots of taxes on the table
Without new legislation from Congress, a
whole host of taxes could go up substantially
at the beginning of 2011. Regular income tax rates for nearly
everyone could go up as a result of the sunset provisions within
the provisions of the 2001 tax cuts. Rates on capital gains, which
have been held to a maximum of 15%, would rise to 20%. The
, which has disappeared for 2010, will come back to hit households
with a much-lower wealth threshold of just $1 million, down from
$3.5 million last year.
Perhaps most troubling are the provisions that would affect the
way dividend payments are taxed. Right now, investors who receive
qualified dividends enjoy the same 15% maximum tax rate as capital
gains. Without a renewal of that provision, though, ordinary income
tax rates would apply in 2011 in beyond, potentially more than
doubling that 15% rate.
That in turn has some financial experts looking at their
recommendations on how to allocate portfolios across different
types of stocks. With a focus on after-tax income, a big tax change
can make some
look less attractive than alternatives.
Revenge of the munis?
In particular, for conservative investors in high tax brackets,
dividend stocks often compete with municipal bonds as a way to get
the most take-home pay from your investments after taking care of
the tax man. For instance, right now, 10-year municipal bonds pay
an average of just under 2.5%, according to Bloomberg. Under the
current tax rates, that's less than the after-tax yield on these
After-Tax Yield at 15%
Procter & Gamble
Source: Yahoo! Finance as of Sept. 15.
However, things change substantially if dividend tax rates rise.
For top-bracket taxpayers paying close to 40%, McDonald's has an
after-tax yield of just 1.8%, while Kraft's payout falls to 2.2% --
below the current rate on muni bonds. That could lead some
income-seeking investors to pull out of dividend stocks and into
Why the sky isn't falling
Some conclude that despite the advantages of strong dividend
stocks, a massive move by investors out of them could push their
prices lower. Yet there are several reasons to believe that
dividend stocks won't be as sensitive to tax-rate changes as many
First, if you're like many people, you already hold dividend
stocks in a tax-favored account like an IRA to shelter their income
from taxation entirely. The tax deferral these accounts offer make
it irrelevant to you what the current tax rates are -- all you care
about is what they are when you withdraw money.
Second, many companies don't qualify for preferential treatment
on their dividends, so their shareholders already pay ordinary
rates on the income.
(Nasdaq: AGNC) are among the many high-yielding REITs whose
dividends don't qualify for the 15% maximum rate. Similarly, almost
none of the 11% yield of
(Nasdaq: AINV) counts as a qualified dividend. Eliminating
preferential treatment on dividend taxes won't affect those
shareholders at all.
While it's always smart to take tax considerations into account
with your investments, don't let tax uncertainty make you panic.
Stick with a solid investment strategy, and it'll take you far
toward reaching your financial goals.
Remember the Lost Decade? Matthew Argersinger shows you
how you could have avoided it
True to its name, The Motley Fool is made up of a motley
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's favorite torpedo scene is in
The Hunt for Red October
, which he's watched more times than he can count. He doesn't
own shares of the companies mentioned in this article.
Chevron and Procter & Gamble are
Motley Fool Income Investor
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on Procter & Gamble and owns shares of Annaly Capital
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