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Everyone seems to think that the U.S. fiscal cliff resolution and health care reform were neutral for higher-than-average dividend stocks versus other stocks since the qualified dividends tax rates and long-term capital gains tax rates remained equal. This is not true though. Actually, due to the fiscal cliff resolution and health care reform, the relative value of higher dividend stocks fell when we crossed from 2012 into 2013.

Higher dividend stocks were already worth less due to taxes prior to 2013. This is because there is some double taxation for dividends that does not exist for capital gains. In brief, if you reinvest the money you receive as dividends, you are double taxed. If you spend the money you receive as dividends, it is the same as if you realized some capital gains to spend; and you are not double taxed. This reinvested-dividends-double-taxation effect was heightened when dividend tax rates rose for 2013.

The following spreadsheet illustrates these points and more.

Hypothetical Stock

Annual Profit as a % of Market Cap

Annual Profit Retained by Company

Annual Stock Value Increase Due to Inflation

Theoretical Stock Value Growth at 1 Yr. - without Dividends

Annual Dividends

Highest Dividend Tax Rate

Guesstimate Average Dividend Tax Rate

Guesstimate Degree of Dividend Reinvestment

Double Taxation Experienced by Investors

Tax-Adjusted Value of Dividends

Theoretical Stock Value Growth at 1 Yr. - with Dividends

Percentage by Which High Dividend Stock Is Worth Less

Zero Dividend Stock- 2012

6.66%

6.66%

2.22%

8.88%

0.00%

NA

NA

NA

NA

NA

8.88%

NA

High Dividend Stock - 2012

6.66%

2.66%

2.22%

4.88%

4.00%

15.00%

13.50%

66.67%

9.00%

3.64%

8.52%

4.05%

Zero Dividend Stock- 2013

6.66%

6.66%

2.22%

8.88%

0.00%

NA

NA

NA

NA

NA

8.88%

NA

High Dividend Stock - 2013

6.66%

2.66%

2.22%

4.88%

4.00%

23.80%

20.85%

66.67%

13.90%

3.44%

8.32%

6.26%

In the spreadsheet:

(1) I guesstimated that the average dividend tax rate was 13.5% in 2012. In so doing, I guesstimated that 90% of all dividends were earned by people in the 25% and above U.S. income tax brackets.

(2) I guesstimated that the average dividend tax rate will be 20.85% in 2013. In so doing, I guesstimated that 90% of all dividends will be earned by people in the 25% and above U.S. income tax brackets and that the new 3.8% Medicare tax on high earners will be applicable to 75% of all dividends.

(3) I guesstimated that two-thirds of all dividends were reinvested in 2012 and will be reinvested in 2013.

(4) I assumed that all reinvested dividends are reinvested in stock of the company from which the dividends were received. I did this to make the spreadsheet simpler. The results are the same, though, regardless of whether or not the dividends are reinvested in the same company.

(5) I calculated "Double Taxation Experienced by Investors" by multiplying "Guesstimate Average Dividend Tax Rate" by "Guesstimate Degree of Dividend Reinvestment".

(6) I calculated "Tax-Adjusted Value of Dividends" by subtracting "Double Taxation Experienced by Investors" times "Annual Dividends" from "Annual Dividends".

(7) I calculated "Theoretical Stock Value Growth at 1 Yr. - with Dividends" by adding "Tax-Adjusted Value of Dividends" to "Theoretical Stock Value Growth at 1 Yr. - without Dividends".

You may think the guesstimate numbers are too high; but, by far, on a total dollars basis, most investment is done by the wealthy, not by the poor and/or middle class.

In reality, a good analysis is much more complicated than the analysis in the spreadsheet. A good analysis requires that we attempt to estimate versus guesstimate, and that we have an estimate or guesstimate for dividend reinvestment percentage for each individual dividend tax bracket. Also, some dividends received have additional applicable taxes (e.g., state taxes); and some dividends are received in tax-free or tax-advantaged accounts (e.g., a Roth IRA or traditional IRA). Also, some dividends are received by corporations versus individuals, and corporations have different tax rates for dividends received. There are other shortcomings regarding the analysis in the spreadsheet; however, the purpose of the spreadsheet is to illustrate the principles involved, not to provide exact calculated results.

There are five lessons that can be learned from the spreadsheet.

(1) To the extent a stock pays a dividend, it is worth less due to taxes.

(2) This effect is greater in 2013 and beyond than it was in 2012.

(3) To a degree, it makes sense for a public company to lean away from paying dividends and toward other options, which include stock buybacks, adding to cash and/or cash-like reserves, investing in current operations, investing in new operations, purchasing property (which includes assets in addition to real estate), and purchasing another company.

(4) If you own stocks or stock funds that pay dividends, you are going to reinvest the dividends, and you are in a dividend tax bracket greater than 0%, it is generally better to own the stocks or funds in a tax-free or tax-advantaged account. If you own some stocks or stock funds with higher dividends in comparison to other stocks or stock funds you own, you are going to reinvest the dividends, and you are in a dividend tax bracket greater than 0%, it is generally better to own the higher dividend stocks or funds in a tax-free or tax-advantaged account.

(5) When you are considering purchasing a specific stock or stock fund, consider the reinvested-dividends-double-taxation effect along with the other variables.

You may think that none of this matters to you because all of the dividends you receive are tax-free. It matters to you anyway. The price of an investment is based upon its value to all of the potential investors in the investment, and the people with more money to invest have a greater influence on the price. The value of higher dividend stocks to you may not be lower, but the value of higher dividend stocks to investors at large is lower. When we crossed from 2012 into 2013, the relative value of higher dividend stocks to investors at large went down a little due to taxes; and these values were already a little lower in 2012 due to taxes. Higher dividend stock prices have reflected and will reflect this.

Everyone who makes their own investment decisions should be aware of the information in this article. It is particularly important to you if you own or are considering owning a higher dividend stock or stock fund such as General Electric Company (NYSE:GE), Microsoft Corporation (NASDAQ:MSFT), Intel Corporation (NASDAQ:INTC), AT&T, Inc. (NYSE:T), Verizon Communications Inc. (NYSE:VZ), McDonald's Corp. (NYSE:MCD), Johnson & Johnson (NYSE:JNJ), Pfizer Inc. (NYSE:PFE), Proctor & Gamble (NYSE:PG), Chevron Corporation (NYSE:CVX), BP plc (NYSE:BP), or iShares Dow Jones Select Dividend Index (NYSEARCA:DVY). If you own or are considering owning a stock or stock fund like this, please read my previous article entitled "Higher Dividend Stocks Are Inferior". There has been far too much emphasis on buying and holding higher dividend stocks in more recent years―so much so that I believe it has created a small price bubble for these stocks, and the performance of these stocks in relation to other stocks in the intermediate-term has been poor. All higher dividend stocks are not poor investments; but investors should be leaning away from purchasing these stocks now, not toward purchasing them.

Source: How The Fiscal Cliff Resolution And Health Care Reform Impacted Dividend Stocks