I have some good news and some bad news.
First, the good news. According to Standard & Poor's, total dividends paid by companies in the S&P 500 index increased by 11.5% in 2007 and are expected to grow by 9.3% in 2008. Intel (Nasdaq: INTC), Boeing (NYSE: BA), and Walgreen (NYSE: WAG) were among the biggest names that boosted their dividend payments last year.
What's more, 11 companies in the S&P, including NYSE Euronext (NYSE: NYX) and Corning (NYSE: GLW), initiated dividend payments in 2007.
Everything looks good, right?
You knew it was coming
Unfortunately, 2008 might be the last year of broad-based dividend growth across the S&P.
For instance, in 2007, share buyback amounts were even larger and grew at a faster rate than dividends, according to the same S&P report. And while buybacks still return value to shareholders, cash dividends not only force management to be more efficient with capital, they also give investors more freedom on how to reinvest their profits.
Yet perhaps most foreboding for dividend-minded investors is the fact that 2008 marks the last chance to extend the 2003 Bush tax cuts, which reduced the maximum dividend tax rate to 15% on qualified dividends paid by corporations. Unless Congress acts to make these cuts permanent, the 15% rate will not last beyond 2010.
And that's a shame. Consider that dividends paid by S&P 500 companies grew 70% before the act was passed through today, from $146 billion in 2002 to $246.6 billion in 2007. It's also no coincidence that Best Buy (NYSE: BBY) and Microsoft (Nasdaq: MSFT) began paying dividends in 2003.
What the 2003 tax cuts did was reduce the adverse effects of "double taxation," where a corporation pays taxes on its earnings and then investors pay income tax on dividends distributed from the already-taxed corporate earnings. Double taxation reduces the benefits of dividend payments to both corporations and investors alike, and naturally steers management toward generating long-term capital gains, on which investors pay a lower tax rate. Reducing the dividend and long-term capital gains tax cap to 15% leveled the playing field and made both options attractive to corporations and investors.
Not all is lost
Even though the 2003 tax cuts may lapse, dividend-minded investors shouldn't fret too much. For one, once a company has begun making regular dividend payments, it is unlikely to cut its dividend (since that would signal financial weakness to the market).
But if you're worried about what higher dividend tax rates could do to your investment accounts, here are two strategies to consider:
- Tax-advantaged accounts: If dividend taxes increase, tax-advantaged accounts like IRAs may become the best place for your dividend-paying stocks. This way, you can continue to reap the benefits of reinvested dividends without having to pay higher taxes on your dividends each year.
- Find proven dividend growers: Johnson & Johnson and Procter & Gamble have increased their dividend payments for 45 and 51 consecutive years, respectively. While not all companies have such a long track record, there are plenty of companies out there that are committed to returning value to shareholders with cash dividends -- regardless of the tax environment.
These are exactly the types of dividend stalwarts that Motley Fool Income Investor advisors Andy Cross and James Early recommend to subscribers each month.
If you'd like to learn more about the Income Investor service, we offer a free, 30-day, full access trial. There's no obligation to subscribe. Click here for more information.
Fool contributor Todd Wenning believes in tax-free shopping and tax-free dividends. He owns shares of Procter & Gamble. Johnson & Johnson is an Income Investor pick. Microsoft, Best Buy, and Intel are Inside Value selections. NYSE Euronext is a Rule Breakers choice. Best Buy is also a Stock Advisor recommendation. The Fool's disclosure policy is tax-free all the time.
