Taxed Twice and Still a Good Deal

If you think it's not fair that so much of your income gets lopped off by Uncle Sam and his friends at the IRS, you probably won't be thrilled to know that your dividend income gets taxed twice. It's true, though.

First your company pays. Then you pay.

Here's an example: Think of how PepsiCo (NYSE:PEP) generates billions of dollars of revenue each year. Its 2008 sales totaled $43 billion, for example. From that sum, it had to pay creditors and employees, as well as buy marketing services and raw materials, and so on. And although it got deductions for many of those expenses, it also had to pay taxes.

Meanwhile, it also sends money to shareholders -- currently $1.70 per share in dividends annually. If you own 100 shares of PepsiCo, you'll receive $170 during the year, and that will be taxable income to you, taxed at up to a 15% rate.

The bad news is that the dividends you pay tax on aren't deductible on a corporation's tax return. That means there's a double tax bite on many investor dollars.

The good news, though, is that dividends still pay off in the long run. Lots of studies have shown that if you remove dividends from the equation, stock investments lose most of their punch. Historically, from 1871 to 2003, 97% of returns came from dividends. Moreover, exceptional dividend payers can perform exceptionally well during bear markets.

What to do
So go ahead and look for some dividend payers for your portfolio. Here are some I found by screening at Motley Fool CAPS for highly rated large-cap stocks with yields of at least 3%.

Source: Motley Fool CAPS, Yahoo! Finance.

That's not a rush-out-and-buy list, but instead a list for further study. Motley Fool CAPS can get you started with gathering information and opinions. With lots of dividend-paying stocks out there, you'll have no shortage of companies to research!