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My Readers Have Been Frantic About This RumorBy
Monday, June 21, 2010
"The tax rate on your dividends is about to triple," leads a recent Forbes article.
The article claims dividend taxes are about to increase to 44.6%, and that this change is going to put "selling pressure" on high-income stocks like preferred shares and utilities.
We've been buying these high-income stocks for years in my newsletter The 12% Letter. And I've been getting frantic e-mails from my subscribers about this rumor. Many of my subscribers are retired. They live off dividends. They can't afford a 25% pay cut. "It'll destroy my standard of living," one reader wrote.
Others are worried about the value of their income investments. If dividend taxes triple, investors will dump high-yield stocks and cause a crash in dividend stock prices.
Fortunately, there's no truth to this rumor. Your dividend taxes are not about to increase to 45%.
In 2003, President Bush signed a law limiting tax to 15% on qualified dividends (a dividend is qualified based on how long if you've held the stock). It was part of a huge tax cut package people call "the Bush tax cuts." The Bush tax cuts expire on January 1, 2011. If Congress doesn't address the situation, after January 1, 2011, dividend income will get taxed at personal income tax rates. For the top income brackets, that means paying a tax rate as high as 44.6% on dividends.
The reality is, Congress will not allow the Bush tax cuts to expire. Both political parties want to extend the Bush tax cuts and it's just a matter of time before they fix the situation. There's no debate here. They'll mostly preserve the Bush tax cuts.
President Obama recently released the final draft of his 2011 budget proposal. This document lays out the most likely tax levels for dividends and capital gains in 2011 and beyond. Obama proposes to maintain the tax rate at 15% on qualified dividends and capital gains for everyone except singles earning over $200,000 a year and couples earning over $250,000.
For people in this tax bracket, he wants to raise maximum long-term capital gains tax and qualified dividend tax to 20%.
What does all of this mean for you?
If your income is above the $200,000/$250,000 threshold, your dividend tax rates could increase from 15% to 20%.
If your income is below $200,000, you have nothing to worry about. You'll keep paying tax at the same level.
If your income is above $200,000/$250,000, I know it's not great news. But I don't expect this change to undermine the prices of popular dividend investments. It only affects a small number of Americans... and 5% is not a big enough increase to make anyone radically change their investment strategies.
In sum, nothing is certain in politics (except taxes). However, it's extremely likely Congress will extend the Bush tax cuts. If you earn more than $200,000, you'll see a 5% tax hike on your investment income. Otherwise, this legislation won't affect you.
As for me, I'll keep looking for the absolute safest income stocks in the market. Last week, for example, I recommended a biotech stock that pays an 18% dividend. This is another perfect income investment for bear markets. The stock market could crash, the banking system could freeze up, and the economy could stagnate, but doctors will keep prescribing drugs and we'll keep getting our 18% dividend.
Good investing,
Further Reading:
The preferred shares Tom mentions today are not just a way to collect high income, they're also the perfect shelter from economic turmoil. Tom has been telling his 12% Letter readers about these high-income "bonds" for over a year. To learn more about them, read: How to Legally Pay Less Tax on Your Fixed-Income Investments.
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