Investors on Edge: Taxes Could Soon Skyrocket

Wednesday, 31 March 2010 12:17 PM

Investors and their advisers can only scratch their heads as they face an uncertain future for U.S. income-tax policy, including one scenario that could send levies on dividends soaring.

During the presidency of George W. Bush, long-term dividend and capital-gains taxes were reduced to 15 percent.

President Barack Obama, backed by many congressional Democrats, wants to raise both rates to 20 percent for married couples earning more than $250,000 a year.

Further clouding the situation, if Congress fails to take any action, the old policy expires and dividends will again be treated as ordinary income and taxed at a rate of up to nearly 40 percent. Capital-gains taxes would go up to 20 percent.

"No matter who is doing the planning, we're all guessing as to how high the rates might rise in the future," said Robert McKenzie, a tax lawyer at Arnstein and Lehr.

Most political observers expect Congress to address the issue, although many wrongly predicted the same thing last year before estate tax rules expired without a new policy in place.

The result is a state of limbo, where financial advisers can only stand back and wait for greater clarity.

Tax cuts enacted in 2001 and 2003 are set to expire at the end of this year, and if Congress takes no action, all rates for individuals in all brackets will revert to pre-2001 levels.

Obama and the Democrats want to extend the cuts for all but the wealthiest two tax groups.

Sander Levin, acting chairman of the tax-writing Ways and Means Committee in the U.S. House of Representatives, said this month that he intended to take up expiration of the Bush-era dividend and capital-gains levies when Congress returns from its two-week Easter break that began last week.

The lawmaker believes House Democrats back Obama's policy of boosting rates for the wealthiest investors, but said the debate would be tougher in the Senate, where Democrats hold a slimmer majority and both sides of the aisle tend to be more conservative.

"We're going to have to force the issue," Levin said.

Despite their intentions, lawmakers could be weighed down by partisan gridlock. Senate Republicans blocked the effort to extend the estate-tax rules last year, letting them expire but paving the way for a big automatic jump next year.

Amending income-tax policy may be even more important for Obama, as he pledged during his campaign not to raise taxes on families making less than $250,000.

If the law expires with no congressional action, he will have broken that promise.

Still, those who counsel some of America's wealthiest families say there are no guarantees Congress will take action, especially in the current political environment. "It's a pretty good bet Congress will not act and the 39.6 percent maximum marginal tax-rate reverts," said Wilmington Trust Investment Management Chief Investment Officer Rex Macey.

"The world is expecting 20-20, but we could end up with 39.6 percent on dividends and 20 percent on capital gains."

Even so, financial advisers contend it is too early for investors to make drastic changes to their portfolios. A 20 percent rate, though more costly, is manageable.

"There is no real rush to sell high-yielding stocks," Macey said. "But if the rate goes up to 39.5 percent, that will create some tremors and discussion in boardrooms around their dividend policy."

Investors will pay less for a stock if its after-tax returns are reduced — and more than doubling the dividend rate would seriously erode cash payouts. Higher dividend taxes would probably also result in increased stock buybacks.

For now, advisers say all they can do is watch and wait. "Given the current environment, there will be a change," said Elizabeth Schlueter, head of wealth advisory for JPMorgan Private Wealth Management. "We're not real sure what that change will be, but we are keeping a close eye on Congress."

Some advisers played down the dividend tax as just one of many issues needing attention. The greater concern from high net worth investors is that tax rates are rising for everything.

"If the Obama administration changed one area, you might see a distorted effect," Evercore Partners Wealth Management portfolio manager Bill Vaughn said. "But we're probably going to see higher effective taxes across many areas."

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Investors and their advisers can only scratch their heads as they facean uncertain future for U.S. income-tax policy, including one scenariothat could send levies on dividends soaring. During the presidency of George W. Bush, long-term dividend andcapital-gains taxes were...
Wednesday, 31 March 2010 12:17 PM
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