For wealthy individuals, paying a higher tax rate on dividends could be on the horizon under the new Biden administration, though this is far from certain given the countercurrents and political rancor in Washington.
What will happen in Washington in terms of tax policy after President-elect Biden takes office is hard to guess, and details of plans for a dividend tax are little known. A spokeswoman for the Biden transition team referred Barron’s to a tax policy paper on its website calling, among other things, that “those who earn more than $ 1 million should pay the same rate for investment income as they do for their wages”. The investment result includes dividends and capital gains.
Under applicable U.S. tax law, those in the highest income bracket – starting at $ 523,600 for single taxpayers and $ 628,300 for married couples filing together – are subject to a 20% tax rate on capital gains and qualifying dividend income. There is also a Medicare surcharge of 3.8%.
“It is premature to make any really important decisions based on this negative scenario,” said Charles Lieberman, managing partner and chief investment officer, Advisors Capital Management. Still, he says, if “they raise dividend tax rates to make them subject to the same tax rate as earned income, it will be negative for dividends.”
With tight control over both houses of Congress, the Democrats will have a leg before any laws they want to pass as new Vice President Kamala Harris is able to break 50-50 votes in the Senate.
But “the Senate is a really complex entity to deal with, and that will certainly affect what is achievable on the tax side because every idea Joe Biden put forward in the campaign is simply not democratic Has unanimity. ” says Michael Townsend, vice president of regulatory and legislative affairs at Charles Schwab.
In terms of Biden’s to-do list for tax changes, Townsend ranks corporate tax rate – Biden plans to increase it from its current 21% to 28% – and “maybe reset the highest individual tax rate to 39.6%” of 37% as “the most likely full buy-in from Democrats “.
“When you go beyond that, within the democratic caucus it becomes more and more complicated what anyone would support,” he adds.
One important consideration, Townsend said, is what spending initiatives Biden will pursue, possibly including infrastructure legislation and other economic incentives. “Things with high expense prices will be associated with some of these tax considerations,” he says. “In that sense it becomes a kind of numbers game. This includes a mathematical element as well as a political element. “
An important question for investors, according to Townsend, is when tax changes take effect, although he doesn’t expect anything to be imposed retrospectively.
Chris Senyek, chief investment strategist at Wolfe Research, points out that there certainly is precedent for higher dividend tax rates. “In the past, dividends were always taxed at the same tax rate as your marginal tax rate,” he says, adding that laws passed under President George W. Bush in the early 2000s lowered the tax rate.
He says tax revenues from capital gains are much higher than those generated from dividends, and therefore could be a more welcoming target for an interest rate hike. “My suspicions, however, are that if there is a change in capital gains taxation, they will be capital gains and dividends, and they will increase them to any rate at the same time,” added Senyek.
However, he and others Barron spoke to for this column don’t expect the tax rate on dividends to be as high as the tax rate on ordinary income, regardless of what scenario unfolds.
The question also arises of whether a higher dividend tax rate for top earners would change corporate behavior. One scenario: “If they increase the tax on dividends, it can result in companies paying less of their profits into dividends and potentially pushing them to buy back more shares,” says Lieberman.
Senyek wonders if a higher dividend tax rate would lead to fewer dividend initiations and smaller increases. If a company “decided not to pay the dividend and invest it back in the company, that is ultimately a capital gain,” he says, adding that “in theory, you can hold the stock forever and pay the taxes later. “In contrast, a dividend is subject to taxation every year – and potentially a less attractive way for a company to return capital if the tax rate rises significantly.
Jenny Van Leeuwen Harrington, CEO and Portfolio Manager at Gilman Hill Asset Management, sees no change. “If [companies] If you look at the shareholder base, the vast majority will not be affected by a tax hike, ”she said in an email to Barron’s. She adds that most shareholders would be upset about a dividend cut, which would make such a move less palatable to companies.
Subscribe to Newsletter
retirement
Barron’s brings you prevention and advice in a weekly roundup of our articles on preparing for life after work.
Meanwhile, Senyek notes that “higher-yielding dividend stocks are a major risk if the tax proposals are released,” but sees no reason to abandon those holdings.
For one thing, the yields on the 10-year US Treasury note have risen, most recently to around 1.1%, but they are well below the dividend yield of the S&P 500 of 1.5%. “If you have a dividend strategy where you have a lot of higher-yielding names compared to government bonds,” he says, “what are you going to sell and buy?”
This is a fair question, made more difficult by the possibility of a higher dividend tax for those who make more than $ 1 million a year.
Write to Lawrence C. Strauss at [email protected]