With election season behind us — and little meaningful change in Washington — investors are now turning their attention back to the looming fiscal cliff.
I can see why!
It’s not clear that either side is really going to budge and if a deal isn’t reached a number of tax rates are automatically going up in 2013 (along with 70+ tax breaks that will expire).
One of the most widely-discussed issues is the tax treatment of dividend payments.
Most investors are currently paying a 15 percent annual tax rate on both capital gains and any qualified dividends they receive. But unless a new deal is reached, that favored tax treatment will revert to ordinary income rates come January 1.
That’s bad enough. What’s worse is that ordinary income rates are ALSO set to rise on January 1 by as much as 4.6 percentage points.
So a taxpayer in the highest bracket could quickly find themselves handing back 39.6 percent of their dividend income rather than just 15 percent!
Oh, and there’s also an additional 3.8 percent Medicare tax that would also go into effect on wealthier Americans’ unearned income — which includes dividends — as well as new limitations on itemized deductions.
Add it all up and the top marginal tax rate on dividends could go all the way up to 44.6 percent!
Already, the market has reacted unfavorably to this possibility — with many higher-yielding categories of stocks taking it on the chin after President Obama’s re-election.
Yet I Do NOT Think Most Investors Should Stress Over
The Issue of Higher Dividend Tax Rates. Here’s Why …
For starters, there is a good chance that the treatment of dividend taxes will be one area where a compromise is reached — especially when it comes to Americans making less than that magical line-in-the-sand figure of $200,000 a year (or $250,000 married filing jointly).
And even if dividend taxes DO jump sharply in 2013, the situation is easily rectified by holding your stocks in tax-sheltered accounts!
For example, the dividend portfolio that I run for my 65-year-old father is safely tucked away in a traditional IRA account. That means Uncle Sam isn’t even getting one single penny of his dividend payments.
Sure, my dad will have to pay taxes on all the money he’s making at some point … but we can control how and when that happens. And with some careful planning, we’ll be able to lessen the overall tax rate he ultimately pays on all of his earnings.
Moreover, if you choose to buy your dividend stocks in a Roth IRA — or you previously rolled your traditional IRA into a Roth as I’ve suggested in the past — then you will NEVER pay taxes on the dividends you’re receiving!
What if your dividend stocks aren’t in a tax shelter? Or getting them into one just isn’t feasible?
Then lawmakers could literally be cutting your income in half for 2013. That’s just another way in which they are outright assaulting anyone who actually depends on the income they receive from their retirement nest eggs!
Yet that still doesn’t mean you should sell your dividend stocks. Here’s why:
First, most dividend stocks continue to yield far more than just about any other relatively safe income investment right now. Heck, I have some recommended stocks that are paying three or four times as much as Treasuries or other fixed-income investments.
In other words, half of that income is STILL more than all the income you’d receive from the alternatives.
Plus, as I’ve pointed out many times before, your dividend payments can grow over time. That is not true of most of the alternatives.
So in the end, we’ll just have to wait and see how this all plays out over the next few months. But I do not recommend making any knee-jerk moves because of all the mainstream media talk regarding dividend taxes.
In fact, I think smart investors — especially those using tax-advantages accounts — should view any further sell-off in blue chip dividend names as a potential buying opportunity.