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Tax Reform May Increase Taxes on Dividends

As we age, we learn to love a certain part of our investment portfolio more and more. When we’re young, full of life, and willing to take big risks, we’re happy to have those high energy momentum stocks and aggressive stock funds that include stocks like Apple that can’t seem to stop going up. As we get older we figure out that we can’t take as many chances with our retirement money as we once did.

That’s when the dividend payers like Johnson and Johnson, Exxon, Pfizer, and Microsoft, just to name a few, start to look a lot more attractive. As we reach retirement age, we may depend on these dividend payers to supply income for living expenses when working is no longer an option.

This is why recent proposals by the Obama Administration have financial advisers as well as income investors worried. How could the recent corporate tax cut proposal affect your portfolio?

The Proposal

The proposal to cut the corporate tax rate from 35% to 28% [3] makes sense in light of America having the highest corporate tax rate of any advanced economy but along with that cut, Obama wants to cut out many of the corporate loopholes as well as raise the tax on dividends. In reality, larger corporations pay closer to 18% [4] after the deductions, credits, and exemptions are applied to their taxable income but this proposal could effectively raise the rate.

The Impact

Movements like Occupy Wall Street want to see corporations pay their fair share of taxes but for corporations who are paying dividends to shareholders, more tax could mean less in dividends, according to Forbes [3]. Not only would the business face potentially higher taxes, the tax on dividends could see a substantial increase. Right now, the dividend tax is 15% but that rate could more than double in a worst case scenario leaving that dividend subject to double taxation and severely eating in to the money retirees have to live on.

More Risk

If the income stream from dividends were to dry up, investors would be forced to take on more risk for both themselves and their clients if they are money managers. As we know from the events of 2008 and 2009, taking on extra risk could potentially have disastrous results for a portfolio and with treasuries at historic lows, income investors aren’t likely to find the income they need from government debt.

What to Do

First, the new corporate tax legislation has little chance of becoming law any time soon [5] and especially not in an election year. Next, with the upcoming Taxmageddon [6] looming at the end of this year, it’s unlikely that Washington would allow taxes for Americans to rise substantially just as the economic recovery is showing signs of staying power.

That may change in the future, though. Investors are advised to not put all of their financial eggs in the basket of dividend stocks. If you are young or middle aged, ratcheting up the aggressiveness in your portfolio, even a little, may help to make up for any potential loss in dividends as you enter retirement age.

Remember that there is always news and rumors coming from Washington as well as the investment markets but for now, investors are well advised to stay the course and only make small scale changes to their investing philosophy and as always, get help from a trusted and qualified financial adviser.