Dividend Tax Rate Set to Jump

Joel Anderson |

dividends, dividend yield, small cap stocks, best small cap stocksThe recent flap over Mitt Romney's effective tax rate of 15 percent was the issue du jour for about a week during the wild Republican primary, and it called attention to the way that Americans are taxed. Dividends, paid out to shareholders of stock in certain companies, have been very low over recent years after George W. Bush began taxing dividends at a separate, lower tax rate. By taxing dividends at the separate rate rather than as normal income, this allowed many shareholders to keep a large portion of the money they made from dividends.

However, with the Bush tax cuts due to expire at the start of 2013, the dividend tax rate is set to cease existence. Shareholders will once again see dividends taxed as income, meaning that the maximum rate of taxation would rise from 15 percent to 43.4 percent, a combination of the top tax rate of 39.6 percent (returning to its pre-Bush cut rates) as well as an additional 3.8 percent tax on income from investments that was part of the Affordable Care Act.

Pros/Cons of Higher Taxes

The taxation of dividends is a complicated issue with a number of ins and outs. There are those that argue that any taxation of dividends is unfair. Dividends are a means of sharing corporate profits with shareholders, who are the owners of any publicly traded company. As such, the profits being paid out to shareholders have already been subjected to corporate taxation and shouldn't be taxed again, according to some.  However, still others argue that the dividend tax is important, helping to share the tax burden between those lower income individuals and the super rich, who receive the largest portion of dividends.

There's also the consideration for how different rates of taxation on dividends can affect the economy. Low rates of taxation on dividends promote stock ownership over time and investment rather than trading. If shareholders can keep a larger share of dividend profits, it means that they have an incentive to hold the stock for longer. This promotes more stability in the markets and can foster a more positive atmosphere for companies to grow.

What this Means to Government

With the United States Government strapped for cash, the increase in tax revenues expected with the increase in taxation could help in paying down the federal deficit. With Republicans and Democrats likely to engage in a major fight over which provisions of the Bush tax cuts to extend, it seems entirely possible that the low dividend rate investors have been enjoying for the last 12 years may be in its last throes unless November's election brings serious changes.

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