Tax law changes make dividend-paying stocks the choice for the future.
As people begin to understand the administration's new tax policy, we're going to see a dynamic shift in investment philosophy-not just by professional advisors, but also by individual investors and corporate leaders.
The last dynamic change in tax policy was created under the 1981 Economic Tax Recovery Act, which created a tax preference for capital gains. At the time it seemed impossible that people would ever invest in stocks again. So in order to get the economy moving and to allow companies to compete, the tax on capital gains was lowered.
The government did not hand investors a capital gains windfall out of the kindness of its heart. The strategy was to draw investors back into the stock market. What happened? Only the longest economic expansion in history. The Dow soared from 777 to 11,600-a stunning 15-fold increase in value.
If the capital gains tax preference could bring investors back to the market after one of the worst long-term performance cycles on record, then what is the dividend tax preference likely to do today? Human nature tells us investors will rush to take advantage of the tax benefits being offered.
This new tax bill may have signaled the next bull market. But, in order to catch this wave, you are going to have to throw out what worked in the past and focus on what will work in the future: namely, buying stocks that pay dividends.
Changes In Tax Policy
Four basic changes to the tax law are a boon to your clients:
1. Federal income tax rates were reduced on ordinary income. The top federal tax bracket was reduced from 38.6% to 35%, reducing the amount of tax investors will have to pay on interest from savings accounts, money markets, certificates of deposit and bonds.
2. Federal income tax brackets were expanded, increasing the amount of income an individual could have and still qualify for a lower bracket. For example: In 2002, a married couple filing a joint return would move to a tax bracket higher than 15% when their taxable income exceeded $47,450. Under the new law, the same couple will be able to book taxable income up to $56,800 and still pay tax the 15% rate. This expanded bracket will allow more investors to take maximum advantage of the lowered capital gains and dividend rates.
3. Long-term capital gains tax rates were reduced from 20% to 15% for investors with taxable income that would place them in a tax bracket higher than 15%. Long-term capital gains rates were reduced from 10% to 5% for investors with taxable income that would place them in a tax bracket at or below 15%. Because of the expansion of tax brackets, many people who were paying 20% tax on capital gains will find their new tax rate reduced by 75%, to 5%. The new capital gains brackets apply to sales taking place after May 6, 2003.
4. Dividend tax rates were also reduced and will now be taxed on "Schedule D" of the income tax return, like capital gains. Beginning with the 2003 tax year, dividend income that had previously been added to all other ordinary income, ballooning taxable income, will no longer be included in the ordinary income calculation. ,This will allow many investors to fit into a much lower tax bracket on all other ordinary income, but the major change is that dividends will be taxed at capital gains rates. Dividend tax rates were reduced from ordinary income tax rates, which had been upwards of 38.6% for high-income investors. These same high-income investors will now only pay 15%-a 61% reduction in tax. Investors with taxable income that would place them in the 15% bracket or lower will now pay only a 5% tax on their dividend income. That's right-just 5%. And because of the expansion of tax brackets, many more middle-income investors will enjoy a dividend windfall paying 75% to 85% less tax on their dividends. Eureka!