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The Fiscal Cliff: Are Dividend Stocks Doomed?


If you're just waiting to collect the final dividend payments of the year before dumping these stocks, you may want to hit the pause button.

The list of companies offering super-fantastic dividend deals – just in time for the holiday season! – is growing by the day, along with those who are moving up their dividend payout from January 2013 into December of this year. The reason is fairly straightforward: Corporate honchos have little or no faith that Congress and the president will reach an agreement averting a lemming-like rush over the "fiscal cliff" by January 1, or else they don't believe such an agreement will extend the current favorable tax treatment for dividends.

It's not just altruistic concern for the welfare of shareholders that is driving this, of course. In a number of cases, when a company's founder or CEO has a majority interest or significant stake in the business, shifting the dividend payout date will save that person millions in potential tax liabilities. Wynn Resorts (NASDAQ:WYNN), for instance, is planning to pay a special dividend that will total $750 million this year; majority shareholder Steve Wynn is likely to save some $20 million in taxes on that dividend income if it is paid out this year instead of in 2013.

In other cases, paying out a big special dividend might get activists off the backs of companies sitting on top of big mountains of cash. There's also the opportunity for CEOs irked at the election outcome to use the timing of dividend payouts to highlight their concerns about what they fear will happen to the country's economy during President Obama's second term.

The taxes paid on dividends and capital gains are artificially low today, having been slashed to only 15% in 2003 by President George W. Bush from a rate as high as 39.6%, the top ordinary income tax rate, prior to that. There is an argument – made by Wynn, among others – that if the government raises that level or allows it to move higher automatically on January 1 as part of the fiscal cliff package, then companies won't pay out as much in dividends and governments therefore won't collect as much in tax revenue.

Here's my read on this situation: Companies typically pay or increase their dividends if they can't think of a better use for all their cash. If lower tax rates really inspired companies to up their payouts, then the dividend yield on the S&P 500 (INDEXSP:.INX) would be a lot higher than its current range of 2.27% (which, in itself, is higher than it has been of late, thanks to the sudden flurry of dividend payouts and the recent dip in the stock market). While yields did climb during the 2008/2009 period, that, too, had more to do with the decline in prices than an increase in dividend payouts. Yields haven't been north of 3% in about 20 years, even as corporate cash levels soared to more than $2 trillion, according to some calculations.

So it seems more logical to assume that businesses made their decisions to pay out dividends, and at what level, based on whether they expected the payout to result in a higher stock price, and not on the tax consequences to shareholders.

At the same time, it's hard to imagine that companies sitting on cash will scale back their dividends. Indeed, if anything, they will likely come under greater pressure to return unused capital to investors via either dividends or buybacks, or invest it in some other way to fuel earnings growth.
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