Will Tax Increases on Dividends be a Non-Event? - Value Investing ...

Expiration of Bush Tax cuts a non-event?

The immediate concern for dividend paying stocks is the expiration of the Bush era tax cuts. Dividends will be taxed again as ordinary income and at much higher rates.

If tax rates rise as scheduled, taxpayers in the top marginal income tax bracket could see the tax on their qualified dividend payments rise from 15% in 2012 to 39.6%. Factoring in of the scheduled Medicare tax on net investment income of 3.8%, and the personal exemption phaseout and limitation on itemized deductions, the total tax on dividends could reach 43.4% in 2013.

The question becomes will higher taxes on dividends cause investors to abandon their dividend paying stocks or will it be a non-event?

Fidelity highlights several reasons as to why it could be a non-event.

Historical Performance

If tax rates are a significant driver of performance for dividend paying stocks then dividend paying stocks should have outperformed the market after the Bush tax cuts went into effect. They did not.

The research team divided the market into five groups based on the size of the stocks? dividend yield. If dividend tax rates meaningfully affected dividend stocks? performance, the expectation would be that the highest-yielding stocks led the market around the time of the 2003 tax cut. The researchers found no such evidence.

Image courtesy of Fidelity. Click image to enlarge.

Ownership

The second reason why this could be a non-event is who holds dividend paying stocks and how they are held.

A large portion of equity assets are held within tax-deferred and tax exempt accounts.

Start with the fact that in 2010, 34.4% of investors? equity assets sat in tax-advantaged accounts such as IRAs and 401(k)s. A dividend rate increase has no impact on those accounts. If dividend rates do rise, investors might want to sell the dividend stocks they hold in taxable accounts, but they could easily replace them by buying shares in tax-advantaged accounts.

Also the majority of dividend income went to the top marginal tax bracket, over 56%, but only 3.3% of the their income comes from dividends. As the author states, while the tax rate on dividends is a large jump it will have a minimal affect on the total income and tax bill to the top tax bracket.

The authors also highlight several reasons why investors, especially retirees, will still want to accumulate high quality dividend paying stocks regardless of the tax policy. Read them after the jump.

Dividends and Taxes: Why market forces may continue to support dividend-paying stocks (Fidelity)

Related posts:

1. Pepsi Increases its Dividend
2. Fallen Angels Report: Under the Radar ~ People Over 60 are Buying Stocks Again
3. Avoid the Yield Trap

Source: http://valueinvestingcenter.com/2012/09/24/will-tax-increases-on-dividends-be-a-non-event/

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