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Now that the election is over, investors are more afraid than ever about the potential for higher tax rates to take effect at the beginning of next year. With less than two months to resolve the problem, many investors don't think Congress and the President will be able to reach any sort of compromise on the issue, leaving investors scrambling to do what they can to minimize the tax hit they'll take.
Dividends stand to take the biggest hit, with preferential tax rates slated to completely disappear in 2013. That will cause rates for top-bracket taxpayers to nearly triple. But increasingly, companies are taking steps to help their shareholders by getting dividend income out this year -- by issuing special dividends.
What's so special?
What makes dividends "special" is that they don't come in predictable payouts. Unlike "regular" quarterly dividend payments, special dividends are typically (though not always) one-time events, used when circumstances create a surplus of cash that a company decides to pay back to shareholders. For instance, earlier this year, Vodafone (Nasdaq: VOD ) received a big chunk of money from its 45% stake in the Verizon Wireless joint venture. Rather than using that cash for corporate purposes, Vodafone decided to pay more than two-thirds of the $4.5 billion that it received as a dividend. Similar payouts may come in the future as well.
Other companies make an almost regular habit of paying special dividends. For National Presto Industries (NYSE: NPK ) , a regular annual payout of $1 per share has been supplemented by special dividends for several years running, with the latest installment adding up to a total of $6 per share.
Coming fast and furious
But lately, special dividends are on the increase, and it seems likely that the fiscal cliff's impact on tax rates is at least partially to blame. Late last month, Wynn Resorts (Nasdaq: WYNN ) decided to pay a $7.50 per share special dividend to shareholders. The move is part of an overall strategy to boost Wynn's regular dividend, but the quick timing probably owes itself to tax uncertainty, especially given CEO Steve Wynn's outspoken comments on U.S. business taxation.
But Wynn is hardly the only company making massive payouts. Consider:
- NewMarket (NYSE: NEU ) said that it would pay a whopping $25-per-share special dividend, representing nearly 10% of its current stock price.
- Iron Mountain (NYSE: IRM ) declared a special dividend of more than $4 per share last month, with up to 20% payable in cash and the rest in stock. The distribution will help the company in its attempt to change its status to become a real estate investment trust, which carries favorable tax benefits going forward.
A host of other companies have also made special payouts, and analysts expect many others to join them in the coming weeks. In particular, if lawmakers make no progress toward resolving the fiscal cliff, then getting corporate cash out to shareholders now in the form of special dividends could be the most tax-efficient option companies have to help their investors minimize tax liability.
Should you speculate on special dividends?
The strange thing about stocks declaring special dividends is that they often rise sharply, despite the fact that the only thing the company is doing is returning cash to their investors. In theory, the value of the company should go down by the same amount as the value of the cash it's giving to shareholders, so it's irrational to see shares jump. Yet with so many companies over the years having squandered excess cash, some investors clearly believe that when a company sends money their way, they should reward it by bumping up its share price.
Unless lawmakers surprise everyone by actually reaching a viable compromise to resolve the fiscal cliff, you can expect more companies to add their names to the list of special-dividend payers. With many seeing 2012 as the last chance to capture low tax rates, the companies that pay special dividends will be acting in their shareholders' best interest.
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