If you are a shareholder who likes stocks that pay dividends, then you should be worrying about the fiscal cliff. You see, companies can do any of several things when business is good and they make lots of money. The most common strategies are:
- dole out profit to shareholders in the form of dividends
- invest money in itself by building new plants, acquiring inventory, or otherwise expanding
Some companies are known for paying out dividends. And some are known to be in growth mode: expanding, acquiring, growing, getting bigger, spreading into new territory, etc. In fact, some shareholders may choose to invest in a certain stock because it’s known for paying out nice dividends. Now, that may all change with the Fiscal Cliff.
Nice Low Tax Rate for Dividends Will Expire
The Bush-era tax cuts included a new way of taxing dividends…a special low 15% rate for dividends. Now they are set to expire January 1, 2013. The fiscal cliff occurs that day: and so does this nice 15% tax rate for dividends.That means the income you make from dividends is taxed at 15% no matter what your tax bracket. This rate is going to expire, and if we fall off the fiscal cliff, tax rates on the dividends you receive will probably rise. They will be taxed as regular income, thereby raising your taxable income and possibly putting you into a higher 2013 tax bracket. And if we really fall off the cliff, the income tax brackets will be higher for everyone. As high as 39% for the wealthiest amongst us!
The Tax Code Wasn’t Even Dividend-Friendly to Begin With
Tax code rewards debt and penalizes dividends. There is a nice provision in the tax code that lets businesses deduct the inteerest they pay on debt. That’s debt-friendly. However, when it pays dividends tht’s not a business expense. It’s better to have debt than to pay out dividends. Doesn’t sound like good business practices.
So if a corporation has a profit of a million dollars it’s taxed on that. Very straightforward example here. Now, if it gives half a million in dividends it can’t even say it’s an expense so why would they like to give dividends. They give out dividends and really have no tax advantage to show for it. Better to grow or buy stuff or somehow spend that money so there’s a tax deduction involved.
The Fiscal Cliff and Your Investments
So, for investors that chose certain stocks based on the dividends they pay, you may want to revisit some of your investments if we end up falling off the fiscal cliff. You 2013 tax bracket will make a huge impact on how your dividends are taxed, so it’s a whole new tax strategy from here on out.
Here’s another Way Tax Code is Not Dividend Friendly
Plus, dividends are doubly taxed….first on the corporation and then on the person who receives them. It encourages a corporation to invest its profit rather than pay out dividends. They invest, their value goes up so their stock price goes up. Then they have to pay capital gains tax. But capital gains are taxed at a lower rate than dividends. It just seems that the IRS really hates dividends, no matter how you look at it. Therefore, it seems that dividends will probably fall off the fiscal cliff and shareholders who like dividend stocks will have to regroup.
