Seeking Alpha
Long/short equity, deep value, special situations, growth at reasonable price
Profile| Send Message|
( followers)  

Nothing pleases an investor more than receiving a lot of dividends, and realizing that you don't have to pay any tax on that income.

There are many stocks, which are primarily closed end funds or CEFs, which pay dividends that are tax free. This tax exempt income is generated from municipal bonds in the portfolio. Although many of the Canadian oil income trusts pay income that may be partially or completely tax deferred due to depletion and depreciation deductions, the tax free stocks that invest in munis usually generate dividends that are completely exempt from Federal taxes, and may be exempt from state income taxes as well.

Municipal bonds are issued by states, counties, cities, and other governmental agencies. Income from these bonds is exempt from Federal income taxes, and if the bonds are issued in your state of residence, the income is exempt from state income taxes also. Municipal bonds issued by Puerto Rico and other U. S. dependencies are exempt from state income taxes for residents of most states. There are over 200 different tax free income stocks, according to the recently updated list at WallStreetNewsNetwork.com, with over 30 of them yielding 7% or more, and over 100 generating yields greater than 6%.

Beware of extremely high yield municipal bond CEFs which may use high leverage to attain their high yields. The higher the leverage, the higher the risk. Other issues to watch out for are high management fees, whether the bonds are subject to the Alternative Minimum Tax, and if the closed end fund is selling at a premium or discount.

CEFs are similar to bond mutual funds, in that they own a large portfolio of bonds. However, unlike mutual funds which are priced at the Net Asset Value at the end of the day, CEFs may trade at a premium or discount to Net Asset Value. Obviously, the better buys are the ones that sell at a discount, since it is like buying the portfolio of bonds at less than what they are currently trading at.

For example, the Morgan Stanley Municipal Premium Income Trust (PIA) yields 6.6% tax free from Federal taxes, and trades at a 3.8% discount to net asset value. The management fee is on the low side at 0.4%, but unfortunately the leverage is on the high side at 41.95%. It has been paying dividends since 1989.

The Nuveen California Performance Plus Municipal Fund Inc. (NCP), pays a yield of 6.9%, which is exempt from Federal and California state income taxes. The CEF sells at a 7% discount to NAV and has a management fee of 0.65%. Although it uses leverage at 31.5%, the CEF uses a much lower amount of leverage than many other funds. 17.7% of the portfolio is subject to AMT. The fund has been around since 1989.

For New York investors, you might want to take a look at the Nuveen New York Dividend Advantage Municipal Fund 2 (NXK), yielding 5.8% tax free from both Federal and New York State income tax, and trading at a 7% discount to net asset value. Leverage is only 26.54%, and the fund sports a favorable 0.59% management fee. Only 7.26% of the bonds in the portfolio are subject to AMT. Dividends have been paid since 1999.

You can download an Excel database spreadsheet list of over 200 tax free stocks at WSNN.com. The database contains extensive information including the company, the symbol, the yield, the net asset value, recent price, premium or discount, the leverage, the management fee, when the CEF was founded, the fund's focus (state or national), percent subject to Alternative Minimum Tax, and other information. Keep in mind that both yields and share prices fluctuate, and there is the possibility of bonds in the portfolios defaulting.

Disclosure: Author does not own any of the above.

Source: Closed End Funds for Tax Free Dividends Over 6%