Dividends can carry steep cost
WASHINGTON — Companies are rushing special payments to shareholders to take advantage of lower dividend tax rates before they go up Jan. 1. But investors should beware: Not all special payments are created equal.
Some companies are borrowing a lot of money to make the payments. At others, the payments amount to corporate self-help, rewarding large shareholders who also sit on the board.
In addition to those companies, dozens have decided to move dividends that were scheduled for January into December — a no-brainer when you consider the tax advantage, says Howard Silverblatt, senior index analyst at S&P Dow Jones Indexes.
“Pay me in January or pay me in December: It makes no difference to the company,” Silverblatt says. “As a shareholder, if you pay me in January, you'd better have a good explanation for that.”
That's because a January payment may nearly triple the tax rate that the highest earners must pay on dividends — to 43.4 percent from 15 percent, the rate in place since 2003.
If decade-old tax cuts are allowed to expire at the end of this year, dividends will be taxed like ordinary income, and the top rate for ordinnary income will rise to 39.6 percent from 35 percent.
High earners will pay an additional 3.8 percent to offset the cost of President Obama's health care overhaul.
Obama and Republicans in Congress are fighting over whether the top rate for ordinary income should increase. Republicans would prefer that the dividend tax remain at 15 percent but have not taken a hard line on it publicly.
Between Nov. 1 and Dec. 5, 349 companies moved up their dividends or paid special dividends, according to Silverblatt. That is higher than the 314 irregular dividends paid last year in all of November and December. Silverblatt expects the pace of early dividends to pick up if Washington keeps dawdling.
Many companies go beyond moving up ordinary payments. They are declaring special, one-time dividends to take advantage of the lower tax rate while it lasts.
Those special dividends can dramatically alter a company's finances.
Normally, when a board declares a special dividend, it's a sign of financial strength, experts say. That confidence can attract investors and boost the company's stock price.
But these are not normal times. With so many companies declaring special dividends, professional traders have a warning for everyday investors.
“If they really thought this was the right plan, they would have done it already,” says Peter Tchir, who runs the hedge fund TF Market Advisors. He believes that some companies are not considering the long-term costs of their decisions.
“People should scour these companies and see if they're doing some damage to themselves on the credit side,” he says.
Many of the special dividends, it turns out, are not drawn from the proverbial mountain of cash that companies have been sitting on since the onset of the Great Recession.
Costco last month declared a special dividend of $7 per share, or about $3 billion. To pay for it, the company borrowed $3.5 billion. That caused Fitch, a rating agency, to downgrade Costco, though its rating remains relatively high. Costco declined to comment.