Skip to comments.Racing to Beat the Clock on the Dividend Cliff
Posted on 11/27/2012 7:00:11 AM PST by Kaslin
On the first day of 2013, the amount of taxes that top U.S. stock market investors will have to pay on the dividends they earn will increase. The only question at this point is by how much. Will taxes on dividends rise from 15% to 18.8% because of the ObamaCare tax on investment income that will take effect on that date or will dividend taxes rise from 15% to 43.4% thanks to the additional tax increase related to the 2003 Bush-era tax cuts that are currently set to expire after the last day of 2012?
That question matters today because, as expected, influential investors are pushing companies to boost their dividend payouts in December 2012 to beat the clock on the dividend tax increases that will take place in 2013.
Here, because about two-thirds of all the ordinary and qualified dividends that will be subject to the higher dividend taxes are earned by people with household incomes over $250,000, at least if you go by the IRS' tax return statistics for 2009 [Excel spreadsheet], the most recent year for which data is available at this writing, and because these same people who will be most subject to the higher taxes are the ones who have the ability to affect the amount and timing of corporate dividend payments, all investors will be affected by their response to the tax increase. [We should note that this point will likely be lost on the more clueless commenters of Seeking Alpha.]
That brings up an interesting question. Where will the companies that act to boost their dividends in 2012 get the money to pay them?
Today, we can reveal that the companies acting to beat the clock on higher dividend taxes for their shareholders are pulling the money to pay them from the funds that they might otherwise have used to pay dividends in the first quarter of 2013:
In our chart, we observe that the expected dividends expected to be paid out in the first quarter of 2013 has declined sharply in the weeks following the 6 November 2012 re-election of President Barack Obama, which ensured that these dividend tax increases would take place. Meanwhile, we see that the level of dividends expected to be paid out in later quarters of 2013 are very little changed - it would seem that only the amount of dividends expected to be paid in 2013-Q1 have been affected in the weeks since higher dividend taxes in the U.S. became a sure thing.
The reason why has to do with the way companies actually accumulate the funds to pay their dividends, where they set aside money well in advance of the dates the payments will be recorded, or transferred to their shareholders. Here, the actual funds to pay out dividends in 2012 are being pulled from the funds that are already being reserved to pay dividends in the first quarter of 2013.
So it's not personal and it's not something that reflects a worsening outlook for the U.S.' economic performance in the first quarter of 2013. It's simply a transfer of income from the future to the present for the purpose of avoiding tomorrow's higher taxes. Exactly the sort of rational actions that we should expect such influential investors to pursue in this situation.
As we close, we should note that these actions related to higher dividend taxes in 2013 are far from over. While the incentives are such that the immediate focus will be for companies to make either higher or special dividend payments in these last weeks of 2012, the ongoing incentives for dividend taxes are such that dividends cuts will be favored in federal tax law. And right now, there's no imperative for companies to rush to announce those kinds of negative changes in their dividend policies until after the end of the year.
Consider this thought experiment. We've shown that companies today are raiding the funds they've set aside to pay dividends to their shareholders in the first quarter of 2013 for the sake of racing to beat the clock on the dividend cliff. Where might they then get the funds to cover the amount of dividends that they are expected to pay out in 2013-Q1 without negatively affecting either the investors or the economy? Will they raid the funds being set aside to pay out dividends in the second quarter of 2013 or might they cut back on their other business expenses? Will they do it all over again when it comes time to pay out dividends in the second quarter of 2013? And what about the third quarter? How long can raiding the future for sustaining the expected benefits of the present continue?
At a certain point, things that cannot continue will stop. In this scenario, cutting dividends to shareholders will be the easiest way for the endless raids on the future to stop. When that happens, a lot of not-so-influential investors who rely on dividend income for things like their retirement or pension income can expect to find themselves worse off as a result of the federal government's actions to increase its taxes on dividends for the highest income earners.
And that's how those with incomes of less than $250,000 per year will share in the price of paying higher dividend taxes. Just because they don't write big checks to the I.R.S. doesn't mean they won't feel the pinch in their pocketbooks....
Will this portend a return to the playground of malfeasance of the 90’s, i.e. “retained earnings” because divee rates were through the moon? Time will tell....
While it is OK to warn 'the public' about this, but unless Rs in congress want O to leave office being seen as a popular successful POTUS they better not:
1) Save O on dividend or capital gains taxes (any investment taxes)
2) Save O on tax rates (exception below)
3) Save O on entitlement reform
4) Save o On the automatic budget cuts.
For items 1 to 3 Dems rhetoric says these are are only helping the rich and hurting the middle class. On the automatic budget cuts #4 Republicans agreed to and passed these cuts just last year but delayed them until AFTER Os re-election, great move. .
Having won re-election Obama is looking towards his legacy and now he has some wiggle room to diss his base on some compromise to do that,
If all these items 1 to 4 were to go into effect then most predictions are the country would go back into recession.
But this does us no good if congressional Republicans get/take the blame it AGAIN, And they are sure good at that.
All Republicans have to do is to temporarily extend just enough of the tax cuts to ward off the accusation of ‘defending the rich by attacking the middle class’. I am thinking $100K income or less as it is anice round number.
Doing that requires NO R votes for tax increases.
Let Obama/Dems argue why we need the rest of 1 to 4. It's his legacy after all. And if he doesnt make the case for those then the single R message must be that 'Obama raised those taxes and cut military spending destroyed the economy and proved that his policies are a disaster'.
As a life long bookkeeper, I would advise any client I had to so exactly this.
Issue their dividends early...beat the tax clock.
” Let Obama/Dems argue why we need the rest of 1 to 4. It’s his legacy after all. And if he doesnt make the case for those then the single R message must be that ‘Obama raised those taxes and cut military spending destroyed the economy and proved that his policies are a disaster’. “
Already sold my high dividend ETF in my IRA.
I am not sure why one would do this. All income generated in an IRA is taxed as ordinary income. Are you saying you cashed out part of your IRA, or you moved the high dividend ETF to other funds in anticipation of these ETFs getting clobbered at year's end?
Because the price of the eft is trending down on the news that dividends are going to be taxed at. Extortion rates.