The Dividend Question

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Question mark liberal (Photo credit: Wikipedia)

 

Dividend paying stocks have been the darlings of the market in the last couple years. Really, in today’s low-rate environment, where else can an investor find a decent return? Interestingly, we may be about to see that all change.

One of the pieces of the impending fiscal cliff is a tax hike on dividends. If the Bush tax cuts expire, the dividend tax could go as high as the income tax rate. For the highest earners, this would be 39.6%, plus the new healthcare surtax of 3.8%, for a total 43.5% dividend tax. That’s considerably more than both today’s 15% rate and the impending revised capital gains tax rate of 20%.

With this on the horizon, we surveyed our customers to get a feel for what companies are doing (if anything) to prepare for these changes. Here’s what they said:

Almost half of those surveyed expect no changes to current dividend policies even if the tax rate jumps.

For those that do foresee changes in policy, most think uses of excess cash will be reconsidered going forward. This includes eliminating dividends altogether and/or reallocating dollars to things like share-buyback programs. The second most popular prediction is an increase in issuance of one-time special dividends. Many also said they expect to see freezes or reduced dividend rates as well as companies pulling dividend payments into 4Q12.

Obviously, the potential tax hike won’t affect all investors or all companies. Investments made in tax deferred accounts are excluded, and MLPs and REITs may actually benefit from the rule change relative to other operating companies. For the Street’s part, traders have been chattering about potential valuation adjustments for dividend paying stocks in the new year. And, there’s always the chance we will see big changes to corporate tax structures in the coming year which could affect everyone’s capital deployment decisions going forward.  All sorts of excitement for the new year.

Check out WSJ's article on the Dividend Cliff for more color.