It's Time for Patience, Not Panic

11/15/2012 11:41 am EST


Jim Trippon

Editor-in-Chief, China Stock Digest

The election rhetoric has gotten many investors wound up about taxation on dividends and all sorts of other stuff…but now that the election is over, it's time to step back and see what's really going on, asserts Jim Trippon of Dividend Genius.

By the time investors will read this, the presidential election will have taken place. Much speculation has centered around what will happen to dividend investing, with the strong possibility that tax policy changes will take place for investors.

The current tax policy of a 15% rate on both dividends and capital gains has been thought to be likely to change no matter which candidate won the election. The campaign proposals of both candidates included changes, with both Gov. Romney and President Obama drawing the dividing line for taxpayers at an income level of $250,000 for those filing joint returns and $200,000 for those filing as a single payer.

The proposals by Obama and Romney differed, as Obama proposed an increase on the capital gains tax to 20% for the earners above the dividing line, while leaving the rate t 15% for those below. Romney’s proposal was to tax the higher earners at 15%, while not taxing capital gains for those with incomes lower than the $250,000/$200,000 level.

As for dividends, Obama proposed to tax the higher earners at 39.6%, the top marginal rate for ordinary income. The proposals by the candidates illustrated the sharp differences between the two candidates and their parties on taxing investments. Romney and the Republicans believe that lower taxes will spur investment, while Obama and the Democrats’ position was that higher earners should pay a larger share of government expenses.

Complicated Change
Even with the election over, however, as in most things financial, it’s not quite clear or simple as to how the changes will unfold.

In a note released the day before the election, Goldman Sachs’ (GS) David Kostin said in a view many analysts share that investment tax rates were due to rise no matter who won. With the fiscal cliff as well as the Affordable Care Act, which adds a 3.8% tax on top of investments, the capital gains tax would rise to 23.8% and the top marginal rate to 43.4% should the Obama proposals be adopted.

This would be regarded as the worst case scenario for investors, as Kostin thinks it more likely that both capital gains and dividend taxes will rise to 23.8%. Others think there may be further adjustments, with the possibility of a different income dividing line or maintaining two different rates based on different income levels.

It’s always a tricky thing—sometimes futile—for investors to try to anticipate the actions of Congress concerning investment laws and tax policy, even after an election.

But what many investors historically have done, Kostin points out, is when investment tax hikes occurred for 1970 and 1987, they sold off holdings in the preceding Decembers in 1969 and 1986. December, usually a positive month for the market, saw a negative return on the S & P 500 for those months, as investors sold to lock in the lower tax rates.

Dividend Policy Changes
There is the potential, if companies feel that whatever new tax rates might be enacted will negatively affect investor sentiment on their stock, that companies may change their dividend policies.

In the extreme, some companies might eliminate their dividends, or more likely, dividend growth and increases might be slower. Buybacks might be favored more over dividends.

Two groups of investors—the wealthiest, as well as retirees who depend on dividend payments for their sustained income…and these two groups may be partially different but aren’t necessarily mutually exclusive—may find dividend investing less attractive.

Although longer term, capital gains rates and dividend tax rates have not historically been shown to dramatically alter dividend investment behavior on a large scale, the impact is most noticeable and felt when changes in the tax rates initially take place.

For Dividend Investors
So what should you do? Unfortunately, the consensus was that investment taxes would rise no matter which candidate won, so it might be a matter of how much, not if. If you invest in dividend-paying stocks as either a large or small portion of your portfolio, you shouldn’t panic and make dramatic changes.

There has been a lot of warning about these potential changes, so it should have given investors (or their CPAs or other tax planners) enough of a heads-up to assess the situation in light of their personal investing needs, strategies, and investment mix.

Watching and waiting for now, then making prudent adjustments might be the best strategy.

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