Taxes Tomorrow Means Dividends Today

December 12, 2012 13:00 pm

by Charlie · 23 comments

Today’s Courier Herald Column:

All of the maneuvering and negotiations to address the fiscal cliff aren’t happening in Washington.  Quite a few of them are happening on Wall Street and in board rooms across the country.  The very real possibility that tax rates are going up is paying dividends – quite literally.  Companies are issuing special dividends to distribute corporate funds to shareholders ahead of next year’s potential tax rates.

Under current tax policy, corporate dividends are taxed the second time at a rate of 15%.  It is first key to understand that corporate earnings are subject to federal income tax rates of 35%, plus state income taxes which may be as high as 16%.  Dividends are not a deductible business expense.  They represent the distribution of profits to shareholders after corporate taxes are paid.

In the event that no agreement on the fiscal cliff is reached, the “temporary” tax rate that has been in effect since 2003 would expire, lifting taxes on dividends up to 43.4 percent for high income individuals.  That’s just short of tripling the tax rate on dividends.  3.8% of this new rate is from a surtax to help pay for health care reform.  You know, that last time the President “asked” that the wealthy just pay a little bit more of their “fair share”.

The result of the potential tax hike is that companies are rushing to approve special dividends to be paid in December, thus avoiding next year’s tax rates.  Costco alone is paying $3 Billion to shareholders above routine dividends.  Even more peculiar, Costco and others are borrowing much of the money that will be distributed to shareholders.  It is clear that these companies are paying dividends today in lieu of dividends that would have been paid tomorrow.

The result will illustrate what often happens when dramatic changes are made to the tax code.  Behaviors are quickly changed to maximize the benefit of those who would pay the tax.  That’s basic human behavior and critical to any understanding of economics.

Tax receipts for this year, 2012, will go up because of this behavior.  There are some estimates that place the potential for advance dividends paid this year to approach $200 Billion.  At a 15% tax rate, that would indicate that $30 Billion will go to the treasury this year that otherwise would have not.  So that helps the deficit, right?

Not necessarily.  While 2012’s numbers will be temporarily improved, it is also clear that companies will be recalculating their strategies for returning earnings to their shareholders.  Companies, remember, are not required to pay dividends.  We have seen that many companies are more than willing to sit on large amounts of cash in overseas subsidiaries rather than to bring that cash back home and face the 35% corporate tax rate.  They are equally likely to sit on cash or buy back company stock to avoid subjecting shareholders to a 43.4% second tax on their profits.

The result, as we are likely to see, is that the tripling of tax rates on dividends will quite likely see tax collections for dividend taxes go down, not up.  But, after all, much of this exercise really isn’t about increasing revenues to the Treasury.  The President has made it clear that this is about increasing rates, not revenue.  It’s about “fairness”.  Tax policy is being advocated not based on economics, but on elusive goals of economic equality.

The exercise being conducted by corporations and their dividend policies should serve as a reminder that our tax code is complicated and offers many different incentives, many unintended, for changes in behavior because of it.  Ideally, a sound tax system should minimize these opportunities, knows as “distortions” among economists.

A broad based, low, and relatively flat tax system is preferred to get government out of the way as much as possible so consumers and businesses can make the decisions that are best for them without undue influence from the government.  That is the needed message for tax reform.  It’s one of the many that Republicans are not yet making as part of the ongoing tax negotiations.

Scott65 December 12, 2012 at 1:24 pm

Ok…this double taxed argument is misleading. Do you invest to avoid paying tax or do you invest to make money? If its the former…than your argument fits just fine. If its the later…then it doesn’t. If you work for a company that pays you…you pay the going rate…lets say 35% (just for example). The company paid taxes…so why isn’t this double taxed. If you invested money and made money…why is that so special that it should be 15%. Is Mitt Romney being “double taxed” by paying an effective rate of 13% in some years…I dont think so. Thats why just saying dividends are “double taxed” doesn’t paint the picture quite right. Income on the individual level is income, and it should all be treated the same…thats why we are in the mess we are in.

peachstealth December 12, 2012 at 2:26 pm

If you work for a company that pays you…you pay the going rate…lets say 35% (just for example). The company paid taxes…so why isn’t this double taxed.

You employer deducts what it pays it’s employees as part of the cost of doing business, therefore it isn’t double taxed.

If you invested money and made money…why is that so special that it should be 15%.

It depends on that you invested in. Only dividends that have already been reduced by the corporate taxes are treated this way ( they’re called “qualified dividends”) Dividends from such things as REITS ( Real Estate Investment Trusts) which do not pay taxes, are taxable at your marginal rate. So is any interest you may have earned other that from tax free muni bonds.

Rationallogic December 12, 2012 at 3:03 pm

Thomas Sowell explains it far better than I ever could:
http://www.realclearpolitics.com/articles/2012/10/02/capital_gains_taxes_115635.html

Scott65 December 12, 2012 at 5:35 pm

skip the employer…what they do is irrelevant outside of what you receive (unless they refuse to pay you but thats another topic)…thats my point. Taxes are collected at every step of the food chain…like it or not, thats how it is. You pay someone…they pay tax. Its only complicated because those with the means to influence the congress do so at the expense of everyone else. Whether you made 100.00 because of a smart investment, worked 5 hours, or any other way you would (legally) earn 100.00…its still 100.00 that you earned and what happened before you earned it makes no difference. It should all be taxed the same and at the same rate.
Nice video I watched today on MMT…should be required for a lot of people to watch.

https://www.youtube.com/watch?v=Yiw8Lyw1XGc

peachstealth December 12, 2012 at 6:43 pm

The question is “When did you earn it?” . If you’re the sole owner of a small company, when your company earns a profit if belongs to you.
If you own shares in a corporation you’re part owner of that corporation. When it makes a profit you own a portion of that profit it when it’s earned, not when the board decides to give it to you. Why should it be taxed twice?

Scott65 December 12, 2012 at 8:18 pm

you are only taxed when you sell that portion that you own. If you made money, you are taxed on the profit. If you lost money, sometimes you can deduct the loss. Money you earn is money you earn…I see no difference in why their should be preferential treatment of one over the other

peachstealth December 13, 2012 at 9:49 am

You could just tax dividends from “C” corp the same way you tax dividends from “S” corps, partnerships and REITs , with the exception of the corporation paying tax on the portion of the earnings it retains. The portion of earnings passed on to the stockholders ( owners) is not taxed at the corporate level but are fully taxed at the individual level.
It depends on what your objective is. Do you want to raise taxes out of fairness or do you want to collect the most revenue for the government without harming the economy.
The president seem to want to do the former and it looks to me like you do too.

ChuckEaton December 12, 2012 at 1:46 pm

When you pull money out of your checking account, do you consider it income?

John Konop December 12, 2012 at 2:02 pm

You do pay taxes on intrest, not sure what you mean?

ChuckEaton December 12, 2012 at 2:16 pm

I should have been more clear, as my point was not about any measley interest you may or may not receive from your checking account. As Charlie previously stated, the money sitting in a corporation’s bank account has already been taxed, just like the money sitting in a personal checking account has already been taxed (most of the time). When you own stock in a corporation, you own a percentage of all of its assets, including the bank account, when a dividend is declared, you’re simply getting your share of an asset you already own; just like when you pull money out of your checking account – it’s an asset you already own.

seenbetrdayz December 12, 2012 at 2:25 pm

Reminds me of Georgia’s inventory tax. Speaking of which, did anything ever come of the ballot measure that passed in 2010? Last I heard, retail inventory doesn’t qualify for the exemption.

John Konop December 12, 2012 at 3:11 pm

ChuckEaton,

Dividend is the income generated from the business from an investment. This transaction is a hybrid. What I would suggest, that up to 500k total income an individual can make the lower rate, anything over that it should be taxed at an income rate with the 30% Buffet rule. The positive of a dividend is it does attract investment into companies. The negative is it takes away capital that could be interested back into the company. But if capital gains were still at the lower rate and not including into income, than the gain from sell of ownership would be still at the lower rate. The above idea would promote investment into the company over a company just being a dividend play, which would spur growth, while not punishing the investor class.

peachstealth December 12, 2012 at 3:22 pm

You might also add that when a dividend is paid, the value of the stock is reduced by the same amount.
For instance . Southern Company pays a dividend of $1.96 per year. 25% of it is paid each quarter. The last ex-dividend date was Nov 1, 2012. On Oct 31 SO closed at $46.84. The next morning it opened at $46.35 and anyone who owned it at that time was paid 49 cents per share on the pay date Dec 9, 2012

Chris Huttman December 12, 2012 at 2:07 pm

I think the general principle is that a dividend is a capital gain with another name. If I buy $100 of a stock that pays no dividend and makes $10 then next year it will be worth $110. If I sell it, I have a $10 gain.

If I buy another stock that makes $10 and pays it all out as a dividend, that’s ultimately the same thing. And as close to evenly as possible, the two situations should be treated the same for tax purposes.

If my checking account paid interest (those were the days!) and I took that money out – then yes it would be income, same as the above example. If I buy $100 stock, it pays $1 dividend and then I sell it for $99 – same as the checking account example no actual gain.

Scott65 December 12, 2012 at 5:38 pm

If you hire a housekeeper…should they pay tax? Your money is sitting there in checking that you already paid tax on…so why do they pay tax under your rationale

saltycracker December 12, 2012 at 2:07 pm

Charlie,

Good collection of thoughts and your conclusion in the last paragraph is dead on.

Unfortunately folks will not agree with you as they believe they are better off in the winner/looser redistribution (like dirty cash management) or hide the money game (billionaires in mega-roths) and a growing gap between the haves and have-nots.

The politcians, bureaucractic empires, lobbyists and dishonest have too much to loose with a manageable system.

saltycracker December 12, 2012 at 2:15 pm

Disclosure – I like the complicated tax laws, legal loopholes and smart advisors just the way they are and my deadbeat relatives continue to be amazed at how great it is for them……but they need more help……..so thank goodness this is just a blog on what would be right for everyone.

seenbetrdayz December 12, 2012 at 2:21 pm

The result will illustrate what often happens when dramatic changes are made to the tax code. Behaviors are quickly changed to maximize the benefit of those who would pay the tax. That’s basic human behavior and critical to any understanding of economics.

So true.

Somewhat related I suppose: French Prime Minister blasting ‘the rich’ for leaving France after massive tax increases.

http://www.telegraph.co.uk/news/worldnews/europe/france/9738178/Frances-Jean-Marc-Ayrault-slams-flight-of-the-greedy-rich.html

We see similar trends here in the U.S. with the state of California and it’s similar exodus.

saltycracker December 12, 2012 at 2:43 pm

A good reason to slip across the border from Cobb & Fulton to Cherokee.

Chris Huttman December 12, 2012 at 3:44 pm

What you save in measly property taxes you more than pay for in commute times and having your only dining options be Chili’s, Longhorn and Quiznos.

John Konop December 12, 2012 at 4:43 pm

Not true anymore, Cherokee has some great restaurants! Down Town Kitchen GREAT hanger steak and very good wine list, Going Coastal fantastic seafood and very good wine list, Vingenzo’s high end Italian good wine list, Pure Mexican restaurant great Mexican food, I could on and on…………….

saltycracker December 12, 2012 at 5:44 pm

C,

You’re just nervous the big hawks up here would dine on your avatar…..

When I first moved to Roswell my hip friends told me how quaint it was in the sticks where they kept their horses. It changed, so did I.

In most places I’ve been to the residents profess they live in the best place in the world even with the problems of_________. I’d agree because it is a personal choice for a lot of reasons.

SallyForth December 12, 2012 at 8:36 pm

I scooped you on this one yesterday, deh deh.

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