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Is There a Dark Side to the Recent Glut of Special Dividends?

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To avoid expected tax rate increases in 2013, many companies issued special dividends before the end of 2012. Was that smart?

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Vince Martin at Seeking Alpha also argued that borrowing to issue special dividends could hurt companies.
Even if dividend rates do go up, there is a benefit to leaving cash on the company's books (if management can be trusted), as those assets are tax-deferred. Yes, it seems likely that the dividend tax rate will go up in the future; but, at the same, a larger tax bill will come due in about four months. A company that accelerates a dividend payment, moving it from January to December, is making a simply, and likely logical, move; for shareholders in a company like Costco, who is borrowing to fund its $3 billion special dividend, the tap-dancing around the fiscal cliff may wind up being too smart by half.

Of course, savvy investors might also wonder if companies that have rushed to issue special dividends were seeking more to satisfy large shareholders, particularly those from within the boardroom.

"Many investors think that even if a grand bargain is struck in Washington, there is a good probability for dividends and capital tax rates to rise. So, in cases where insider holdings are concentrated in the board and executive levels, there exists not only the incentive but also the capability to declare special dividends," said Chaitanya Gohil, vice president of Markit Dividend Research, according to Time.

Costco's co-founder and director, Jim Sinegal, for instance, owns some 2 million shares of the company, and will collect about $14 million at $7 a share, the Wall Street Journal calculated. At 2012's 15% tax rate, Sinegal would pay $2 million in taxes, but he would have had to pay a considerably larger sum of $8 million at the tax rate of 43.4% this year if a fiscal cliff had not been reached in time. National Beverage (NASDAQ:FIZZ) CEO Nick Caporella, who holds 74% of the company's shares, also saved himself up to $24.5 million in taxes with his company's $2.55 special dividend. (See also: National Beverage Declares Special Dividend. What Now?)

Sinegal was quick to rebut criticisms that Costco's dividend was simply an opportunity for insiders to cash in.

"If the issue is where I personally am trying to take an advantage – I could have done that over the last 30 years. My compensation package has been very modest relative to the size of the company and the fact that I'm a founder," Sinegal said, according to the Puget Sound Business Journal. "It wouldn't be unusual for the founder of a company like this to have 10 times the amount of stock I have.

Ultimately, Morningstar analyst Josh Peters writes that investors should not get too excited about the special dividends that were issued to avert the tax hike.

"Long-term investors in companies that haven't been paying acceptable regular dividends might end up slightly better off than before, and a few short-term traders could wind up with bigger tax bills, but the burst of activity seems unlikely to leave a lasting mark on the market except for this: These irregular dividends are yet another reminder of just how stingy most American corporations are when it comes to paying regular dividends," Peters writes in a market commentary.

Twitter: @sterlingwong
No positions in stocks mentioned.
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