The one-two tax punch on dividends

investment_income_tax_rulesIf President Obama has his way, the top marginal income tax rate will increase by an enormous 13 percent. But that’s nothing compared to the proposed189 percent tax jump on dividends.

Currently, dividends are taxed at the same rate as capital gains — 15 percent. On Jan. 1, dividends will be taxed as ordinary income instead of as capital gains. The rate will, therefore, leap from 15 percent to 39.6 percent for those in the uppermost bracket.

But wait — there’s more.

Back in 2009, the president and then-House Speaker Nancy Pelosi touted “free health care,” but you didn’t really think it was free, did you? Of course, you didn’t. Some of the funds to help pay for Obamacare will come from a new 3.8 percent dividend surcharge, giving us a grand total top tax rate on dividends of 43.4 percent.

Taxpayers generally don’t change their investing habits when taxes increase by a mere smidgen. But when government almost triples them, as it may do here, investors will start looking around for other places to put their money. In this case, they’ll search for places where the income isn’t derived from dividends. Preferred stock and utilities – traditional havens for retirees — will suddenly become less attractive.

But this tells only half the story.

Dividends represent a shareholder’s pro-rata portion of the corporation’s net profits for the period for which they’re paid. Dividends are paid after the corporation itself has paid its own taxes. As a result, corporate profits are taxed twice — first at the corporate level, then at the personal level to the shareholder-owners.

The top marginal corporate tax rate is 35 percent. Add that to the 43.4 percent the president wants shareholders to pay on dividend income, and corporate profits would be taxed at 78.4 percent for the shareholder. Is this reasonable?

This huge increase not only affects the investor, it can also have a detrimental effect on companies — especially utilities — that routinely pay dividends to their shareholders. The following Fox Business Network video explains this in greater detail:


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