Personal Finance Planning for the Coming Dividend Tax Hike

With the possibility of changing tax laws, you may want to prepare by switching how the dividends you now receive are being invested, or what type of account you have invested in. While no one is certain of how these changes will be detailed, it seems that we can count on a certain level of increase in taxes on capital gains and dividend income. Carla Paternak of Investing Answers says this will occur along with the expiration of Bush era tax cuts at the end of 2012. 

The obvious, and probably most wide-spread solution will be to put more dividend growth stocks or funds and automatically reinvest into tax-sheltered accounts like ROTH IRAs or trusts. This can minimize your tax on increased income or values created by capital gains. This is helpful for anyone who can afford to wait for their money to accrue, or those with only a few years until retirement. 

With the new higher taxes to be placed at higher incomes, probably over $200,000 income for individuals and married couples making over $250,000, this would mean about a 4-5 percent increase in taxes. So, you could also explore tax-exempt investments or funds that would be state-specific or federally protected. This is mainly Muni-bonds or federal bonds. Royalty Trusts, REITS, and Master Limited Partnerships are also venues that can be more tax-friendly or at least delay taxes for investors, at certain top-earning levels. These all have complicated delays in accounting and last-minute tax information, so you must be prepared to wait for filing.

Investopedia suggests three methods to prepare for the changes, including the first two mentioned above, and another consideration of Growth funds over Dividend funds. These are for the more experienced investors.

 So, the 1 percent will be paying their dues, while most of us will remain at the top 15 percent rate on dividends and capital gains, including tax exempt status for municipal bonds. The new budget proposal is about taxing the wealthy on dividends at the same rate as ordinary income. The very top income tax rate would go from 35 – 39.6 percent. This is supposed to add 206 billion dollars into the federal accounts in the next decade.

Much remains uncertain, at least until after the elections when the politicians have to deliver on promises. Meanwhile, this is no reason to sell off all your investments. Most people will not be terribly affected and those who will be taxed most can most likely afford it. The main actions needed for preparation will be to look at your timing on capital gains, if you are planning to short-sell stocks or funds.

The hype about the raised taxes on dividends seems to be just that.  It will not affect the great masses of people, with the elimination of municipal bonds tax breaks probably more invasive to upper-middle income or higher groups – capping the deductions on interest payments to the 28% bracket, with interest income above $83,600 for singles and $139,350 for households.

So, again, not to panic or sellout, but to re-distribute where you can, shift to ROTHs, and then just wait and see is the way to go in this limbo of investing.