Under current tax law, dividends paid to individuals are taxed at 15%, but recently the Senate Budget Committee passed a 2011 budget resolution that includes an increase in the top tax rate on dividends to 39.6%. If this stays in the 2011 budget, it would amount to an increase of over 150%. This also does not take into account that under the recent healthcare bill, those individuals making over $200,000 per year will see an extra 3.8% surcharge tax on dividends for a total of 43.4%.
A few key points about dividends. First, many people receiving dividends are seniors living on fixed income. With low interest rates, many retirees have moved to dividend paying stocks rather than Certificate of Deposits, Money Markets… So this huge tax increase will have a major impact on retirees and often these people are not “rich folks.”
Another interesting point is that dividends are already taxed at the corporate level. When a business pays dividends to stockholders, they are not allowed to deduct the payment. In essence paying tax on those dollars, as opposed to spending that money on some other business expense (like interest expense, compensation…) for which they could deduct the payments. For many corporations that tax is around 35%, therefore making the total double taxation on that same income to average out to be over 60 cents per dollar.
Most businesses will not pay this enormous penalty on dividends and therefore search for another solution. They will either stop paying or significantly reduce dividends. They will look to debt borrowings to raise capital for expansions and growth rather than using equity (which often leads to the need to pay dividends).
What does this mean for you? If you are an individual who receives dividend income (or if you know of a retiree), it might be time to start adjusting your investment strategy. If you are a business that has been paying dividends, you may want to reconsider.
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