The Washington Update from Andrew Friedman – Dividend Tax Rate
Published: June 25, 2012
How might a significant increase in the dividend tax rate at year-end affect the values of dividend-paying stocks?
In his budget released last February, President Obama changed his position and proposed allowing the dividend tax rate for families with income above $250,000 to rise in 2013 to the ordinary income tax rate, rather than to remain at the lower capital gains tax rate. The President’s view notwithstanding, most members of Congress appear to prefer keeping the dividend tax rate commensurate with the capital gains rate (although the Democrats would raise both rates in tandem to the low- to mid-20s). Thus, if the parties are able to reach an overall compromise on 2013 tax rates during the year-end lame duck session, they might well keep the dividend tax rate below the ordinary income rate. Absent legislation, however, the Bush tax cuts will expire and the maximum dividend tax rate will increase in 2013 to almost 44%, the same as the ordinary income tax rate.
If it happens, a tripling of the dividend tax rate could affect the value of dividend-paying stocks. Presumably the value of stock purchased solely for dividends, such as public utilities, would decrease so that after-tax percentage returns would remain constant. Stocks purchased partially for dividends and partially for appreciation potential (such as consumer products) could also be affected, although presumably not by as much.
More interesting is whether a tripling of the dividend tax rate could cause companies to change their dividend-paying policies. Companies might decide to keep dividends at their current levels rather than increasing them in future years. They then would use retained cash to re-purchase stock, permitting investors to realize earnings as lower-taxed capital gains. If that happens, dividend-paying stocks could be less desirable as a source of increasing income.
