If you've ever heard that dividends are taxed twice, it's true.
Consider Spray-On Socks Inc. (ticker: PFFFT). Let's say it rakes in $100 million in sales one year and, after subtracting expenses, retains $20 million as its operating profit. Well, Uncle Sam doesn't just pat the company on the back. He demands his share in taxes. Corporate income-tax rates can reach 35% or higher. So, perhaps $13 million will remain after taxes as net profit.
The firm can do many things with that money. It can buy back some of its own shares (increasing the value of remaining shares), pay down debt, build more factories, hire more workers, acquire other companies, and so on. If it pays out some of these earnings as dividends to shareholders, though, the shareholders will recognize the dividends as income. That means Uncle Sam will claim a chunk of that personal income in taxes. Ugh. That money has now been taxed twice -- once on the company's tax return and once on the shareholder's tax return.
This is one reason why investors might prefer to see a company using its money to build more value for shareholders without paying out dividends. It's also why some companies are reducing dividends, opting instead to repurchase shares and reward shareholders in a tax-free way.
Still, dividends are good, overall. They can help make you rich. Learn more in these articles:
- How to Achieve 20% Yields
- Extra Dividends, Extra Growth
- Beat the Market With Less Risk
- How to Be a Dividend Investor
And if you're interested in more ways to make dividends work for you, check out our Motley Fool Income Investor newsletter. A free 30-day trial gives you access to all of Mathew Emmert's top recommendations.