Many investors were upset to find out that dividend taxes have increased in 2013 as part of the fiscal cliff deal. Taxes on dividends didn’t increase nearly as much as they could have if lawmakers failed to come up with a solution to the fiscal cliff. However, the higher tax rates will still erode the returns of many investors’portfolios.
Many investors are wondering what the implications of this new tax are.
How Have Dividend Taxes Changed?
The investors who are going to be impacted by the dividend tax rate increase are those who are in the highest tax bracket. Their dividend taxes have increased to 20% as of the beginning of 2013. Investors in the 10-15% tax bracket will still not receive any form of income tax. Investors in the 25-35% tax brackets will still have their dividends taxed at a rate of 15%. However, many investors making under $450,000 still going to be paying higher taxes because they are paying a higher payroll tax on their dividend income (which is treated separately from the income tax for these purposes).
Protecting Yourself from a Higher Dividend Tax
Any investor who is going to be paying higher dividend taxes will need to take the necessary steps to protect themselves. Here are some things that investors can take into consideration to offset the new tax.
DRIPs Can’t Help
Many investors mistakenly believe that they can avoid paying taxes on their income by using dividend reinvestment plans (DRIPs). Unfortunately, you are still going to have to pay a tax even though you are not receiving a cash dividend, because the IRS taxes all dividends.
You should still consider using DRIPs to help your money grow, but they won’t do anything to protect you from the dividend tax.
Focus on Increasing Dividend Earnings
The best way to protect against higher dividend taxes is to look for stocks that are going to pay higher dividends down the road. You aren’t trying to cut your dividends taxes, but rather decrease the impact they will have on your portfolio. You won’t notice the change as much if your income has increased.
Many people look for stocks that have a history of increasing their dividend yield over time. This can be a prudent strategy, but you are going to have to be cautious. No company can sustainably increase its dividend yield indefinitely. Sooner or later they are going to hit the roof.
You should focus on buying dividend stocks that are increasing their earnings per share each quarter rather than focusing on companies that have a track record for paying a higher yield.
Don’t Let the Higher Dividend Tax Get You Down
The higher dividend tax wasn’t great news for investors or the economy, but things could have been a lot worse. Even the investors earning the highest income can avoid the implications of the new dividend tax if they take the right measures. Focus on increasing your dividend income and you will have an easier time contending with the new taxes.
Kalen is a financial writer and Forex investor who talks about the strategies of John Studzinski, George Soros, William O’ Neill and other financial geniuses.