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Dividend Tax Hike: Bad News For All

Jim Trippon: Dividend Tax Hike: Bad News For All

With all the issues the malfunctioning machines known as the White House and Congress have been trying to tackle these days, it's not surprising that the media and investors have had their attention diverted somewhat. Given the President and Congress this much credit: Whether it is healthcare reform, castigating BP for the Gulf of Mexico oil spill and trying to put other oil companies out of business with a foolhardy drilling moratorium or trying to eat into Wall Street profits with the new financial reform bill, folks have been busy on Capitol Hill these days.

This has moved the plan to hike the tax on dividends out of the limelight, at least for the time being. Politicians are particularly skillful at framing arguments and they have put the dividend tax increase in the context of "Well, it's not going to impact many Americans because the increase only applies to those earning more than $250,000." Hogwash. If the dividend tax rises, it will be bad news for all investors.

I don't want to sound an alarmist tone, but as dividend hunters, we need to know what we're up against. As the non-partisan Tax Foundation puts it, the dividend and corporate tax cuts of 2003 were synchronized, meaning they were implemented at the same time and set to expire at the same time. Corporate profits are first taxed at the firm level and are subject to a combined average federal and state tax rate of 39.1%, according to the Tax Foundation.

From there, income distributed as dividends is taxed at the shareholder level. Allowing the 2003 tax cuts to expire drives the dividend tax rate to over 39% from a current level of 15%, the Tax Foundation reported. Factor in the new Medicare tax on investment income of 3.8% and we'll see an integrated effective dividend tax rate of 68%, according to the Foundation. That is an epic increase that Corporate America and, more importantly, investors simply cannot afford to stomach.

It is really just a political ruse to say "We're just going after the rich" because letting the corporate tax run higher isn't going to motivate a lot of companies to boost their dividends. It's not out of the realm of possibility that if ABC Inc. needs to pay more in taxes, it may opt to conserve cash by not increasing (or cutting) its dividend and that company almost certainly won't be out there hiring new workers if it's faced with a big tab from Uncle Sam.

Those factors have wide-ranging implications for all workers, retirees and investors. As the Tax Foundation put it, 20% of the tax returns filed in 2007 reported qualifying dividends. But 20% of Americans don't make $250,000 a year or more, so if Congress thinks they can limit the damage of a dividend tax increase to the rich, they ought to think again.

An increased dividend tax makes a bad situation worse. Take a look at the chart below. Americans already have their dividends tax at higher rates than investors in the rest of the developed world. The only country with a higher dividend tax rate is Japan and that country's recession has extended to nearly two decades.

Dividend Tax Hike: Bad News For All

The anti-business policies of this White House and this Congress could create a tidal wave that washes away our competitiveness and status as a prime destination for foreign investment. Let's be honest, U.S. capital markets are less than hospitable. CNBC made a big deal about 39 IPOs on U.S. exchanges in the second quarter. Big deal, yeah right. China was home to 170 IPOs in the same quarter and is expected to see 300 new offerings this year.

All of this sounds pretty dour, I know, but I do have two simple ways to make sure Uncle Sam keeps his hands off your hard-earned money. First, consider investing in American depositary receipts (ADRs) from foreign companies that pay dividends. Dividends from foreign companies are taxed the same way as domestic dividends, but many countries withhold taxes on dividends allowing you to turn around claim that as a deduction against your income. Yeah, I'll admit that's not that exciting, but as I noted last week, foreign companies typically pay better dividends and now you know that you might get a small tax benefit as well.

Second, invest in master limited partnerships (MLPs). Fortunately, Congress is not going to alter the tax treatment of this asset class. This is the Dividend Genius way of generating reliable dividend income while realizing substantial capital gains all while sticking it to Uncle Sam.

Committed to your Global Profits,

Jim Trippon

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Global Profits Alert (GPA) is published by Trippon Financial Research, Inc. a financial media organization with offices in the United States, Hong Kong and Mainland China. GPA is written by Jim Trippon in conjunction with George Wolff, Sunny Wang, Jim Trippon, Kelley Damiani and J. Daryl Thompson.

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