Dividends or Share Buybacks: A Taxing Dilemma
With potential tax hikes looming, companies may elect to substitute share buybacks for dividends in the future.
While there's been a lot of talk about the looming "fiscal cliff," rarely does even a highly partisan political divide prevent politicians from cooperating at the last minute to find some sort of temporary solution. Sure, the resolution may neither be prudent nor long-term in scope, but most can logically predict that something will be done. With that said, regardless of how the cliff is resolved, we believe investors should care more about how we'll be paying for the spending that will be incurred. There is a good chance that tax hikes are right around the corner, and those will directly hit most investors' pocketbooks if enacted.
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If Congress does not take any action, starting on Jan. 1, the government will tax all dividends at ordinary income rates instead of the preferential 15% treatment for qualified payouts. On top of that, as part of the Health Care and Recognition Act of 2010, investors whose income exceeds $200,000 or $250,000 for single and joint filers, respectively, will be subject to an additional 3.8% Medicare surtax on all dividends, interest income, and capital gains. This new tax will remain in effect even if Congress extends the Bush tax cuts.
Alex Bryan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.