The economic stimulus package presented in early 2003 by President Bush proposes to make sweeping changes in the way companies behave and the way Americans invest. Totaling $670 billion over ten years, the plan will include a number of tax cuts designed to put more money into the hands of investors. The centerpiece of the proposal is the elimination of taxes that shareholders pay on corporate dividends. Bush dividend proposal facts o Out of tax returns filed in 2000, 34.1 million claimed dividend income. o It will cost $25 billion in 2003 and $280 billion over the next decade. o The cut is meant to help stimulate the economy by allowing investors to retain more of their profits. They might then invest more in stocks, helping to boost the stock market. ABCNews.com Jan. 7, 2003 What are dividend taxes? Corporations pay taxes when they record profits. If the re-maining profits are passed along to shareholders in the form of dividends, the investor is also taxed at his or her income tax rate. By the time this “double-dipping” process of taxation is over, the government can rack up more than half of the profits. For example, let’s say an investor in the 30 percent federal tax bracket owns shares of Company A, which pays a dividend of $1.50 per share. Under the current tax rule, that investor doesn’t get to keep all of the $1.50 per share because 30 percent or 45 cents per share – goes to the IRS. That reduces the after-tax dividend from each share of Company A to $1.05. Since the corporation has already paid taxes on the profits before they were passed along as dividends, the profits have subsequently been taxed twice or “double-dipped.” During the 1990s, dividends were less popular than today because the bull market made investors happy to leave cash in the hands of management, which used it for expansion or to buy back shares. If the price of the stock went up, the shareholder could sell the stock and pay tax at the lower capital gains rate, rather than the higher tax rate that would apply to dividends. However, because of the recent fall of the market and increasing investor skepticism around corporate accounting, many dividend-paying companies have increased their distributions. How would the proposed cut affect the economy? According to the White House, the proposed tax cut would help stimulate the economy by allowing investors to retain more of their profits. As a result, investors would then put more money in stocks, which would in turn help to boost the stock market. Many economists agree that the plan could inflate stock prices, but there is skepticism as to whether or not it would boost business investment or consumer spending. How would the proposed cut affect investors? At first glance, it might seem that the government’s proposed treatment of dividends is of little importance to today’s investors. The dividend yield on the Standard & Poor’s 500 Index currently stands at less than two percent. So, if you had $10,000 invested in the S&P 500 Index, you would receive dividends of $200. Barely one company in five even pays dividends. Ultimately, the amount of benefit an individual investor would receive from the proposal would depend on the amount of dividend-paying stocks that they own. The proposal wouldn’t affect people who own stocks or mutual funds in a 401(k) and/or IRA, because their dividends would remain untaxed initially and would continue to be taxed at ordinary income tax rates once money is withdrawn from the accounts. However, increasing the prominence of dividends could draw reluctant investors back into the market, this time with an interest in cash returns. If people begin to invest for the growth potential of a company’s dividend, they could revitalize a more long-term investment philosophy. They could also count on a more predictable return on their investment. How can I estimate my possible savings? It might seem simple for investors to calculate the effect of receiving dividends by multiplying the total taxable dividends by the marginal tax bracket. However, because the provision is aimed at eliminating double taxation of dividends, it becomes a little trickier. For example, certain types of income are not taxed at the corporate level, such as municipal bond income. And some types of preferred dividend payments are treated as deductible interest payments at the corporate level. Making either type of dividend tax-free would provide a double benefit, something tax experts believe the government doesn’t intend to do. The bottom line is that if your taxable dividends come only from shares of common stock in profitable companies, you are probably safe multiplying the income by your marginal tax rate to estimate the savings. If your dividends come from a mixture of common and preferred stocks, REITs and mutual funds, it is more complicated to accurately calculate the savings. Work with a qualified tax specialist to get a clear picture of how this new package may affect you. As always, your professional financial advisor can also help you to ensure that all your investment strategies are positioned to make progress against your long-term goals and objectives. Bruggers, Lawrence & Associates A financial planning division of American Express Financial Advisors
