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Dividends, Taxes and 2013

The clock is ticking on investors and new tax rates will be effective January 1, 2013, it is time to make the hard decisions about what your portfolio should look like as a new tax regime comes in to force in the USA.

Economist and Hedge Fund Manager Shayne Heffernan takes a look at Dividends and Wall St for 2013.

The tax cuts passed by the Bush administration in in 2003 that cover earned and investment income are set to expire at the end of this year unless  the negotiations over the so called fiscal cliff bring with them a reprieve for investors.

The President and Congress could reach a compromise or agree to delay any increase in existing rates until a comprehensive budget agreement can be negotiated in 2013,  Obama has said that he press for the tax tax increase without compromise, this means the top marginal tax rate on ordinary income would revert back to an onerous 39.6%.

Even worse from a tax perspective is the fact that President Obama increased Medicare payroll taxes by .9% and passed a tax of 3.8% on investment income to finance health insurance reform, this means families with adjusted gross income above a fairly low benchmark of $250,000 are scheduled to face a top rate of 40.5% on wages, 43.4% on interest or dividend income and 23.8% on capital gains.

$250,000 a year does not make you Warren Buffett, actually for an average family with 2 people working, kids in school, cars on finance and a mortgage, $250,000 would define them as America’s middle class, not the 1% that tax hikes have been reportedly aimed at in the Obama speeches.

An increase in taxes on dividends and the subsequent decrease in the amount of cash received from dividends does raise the question as to whether or not this will lower  demand for dividend‐ paying stocks, and without doubt that answer is yes. Investments aimed at capital appreciation look far more attractive to US investors as 2013 approaches.

So, assuming you can not all pack up and become my neighbors in amazing Thailand where foreign income is not taxable, let’s take a look at the likely repercussions of the changes.

So the question now is, by how much will this effect dividend stocks? How will the imposition of a 43.4% top dividend tax rate mean for the expected returns of dividend‐ paying stocks?

Who will be impacted by these higher tax rates on dividend income?

What does the history of dividends and taxes tell us.?

Here are our top 5 things to consider

1) Dividend stocks dominate the Wall St equity market.  Around 88% of the S&P 500 Index’s weight is in dividend-paying stocks. So the reaction here will reverberate around the world .

2) Some investors are tax rate insensitive, such as pension funds, endowments, 401(k)s, and individual retirement accounts (IRA)s (hereafter“Retirement Investors”). If dividend stock prices fall due to higher taxes, Retirement Investors maybe motivated to buy these dividend-paying stocks at their reduced prices.only about 52% of qualified dividends would be subject to the tax increase with that particular income threshold.

3) Dividend ratios have been actually been declining over the last 30 years.  Firms are paying out less of their earnings as dividends and this tax move will see that trend continue, shareholders would prefer capital growth over heavily taxed dividends.

4) In 1993 President Clinton raised dividend taxes, The losers were the low yield stocks the winners were high-dividend stocks.

5) There is no competition, bonds and banks are offering minimal returns that do not keep pace with real inflation, that adds some value back to the dividend stocks, but it may also see more money leave the USA to growth markets like Asia as investors hunt for yield.

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