The most talked-about item in President Bush's $674 billion economic stimulus package is the proposal to eliminate the "double taxing" of dividends. This is something most investors find appealing, and you can read more about it in Bill Mann's (TMF Otter) The Truth About the Dividend Tax.
Should the proposal pass, however, you may need an accountant to figure out what it means for you. A Washington Post story by Jonathan Weisman does a good job explaining the enormous complexities involved. Here are the major points:
- Eliminating double-taxation assumes the dividends will have to be taxed once. And that means corporations will have to track all earnings and pay dividends only out of the pool of fully taxed profits. Further, many companies receive various breaks and pay little or no taxes. These businesses would not be able to offer tax-free dividends to investors. This issue may involve dividend payouts that specify how much of the money was taxed at the corporate level, leaving investors to figure out how much will be taxed at their level.
The above complexity favors well-established, dividend-paying companies. After all, businesses that have operated under the same tax rates for years can offer simple, tax-free dividends. Think of companies such as General Electric
(NYSE: GE), Philip Morris (NYSE: MO), and J.P. Morgan Chase (NYSE: JPM).
- Companies not offering traditional dividends could pay "deemed dividends." This involves management telling investors how much money the business could have paid out in tax-free dividends but chose not to. Investors could then add that to their cost basis, giving it a higher value. When they sell their stock, the higher cost basis may give them a lower capital gains tax.
- It may be a disadvantage to hold a dividend-paying stock in an IRA. You'll be able to retain the entire payout of a tax-free dividend in a non-retirement account, of course. But when you withdraw money from a 401(k) or traditional IRA, it will be taxed.
None of this means you need to make portfolio adjustments right now. After all, the proposal is still a proposal, and it may change drastically as it works its way through Congress -- if, indeed, it makes it through at all.