At the end of this year a change in the tax laws will occur that will impact the treatment of an important part in the investment process -- dividends.
In 2003, Congress passed and President George W. Bush signed the Jobs and Growth Tax Relief Reconciliation Act, which, according to the Tax Foundation, "reduced the double taxation on corporate profits by lowering the top individual tax rate on dividends and capital gains to 15 percent."
However, the lower rates will expire at the end of 2010, the capital gains rate is scheduled to return to 20 percent and the rate on dividends for taxpayers in the highest brackets will go to 39.6 percent.
With only six months remaining in the year, Congress has yet to address this situation and, unless the legislature and President Obama act soon, the rollback to previous rates will occur.
Many members of Congress who support the sun-setting of the tax break on dividends suggest that the reduced rate is just to benefit wealthy shareholders. However, a new report by Tax Foundation says it is really all about double taxation.
"Since the inception of the corporate income tax in 1909 and the individual income tax in 1913, the return to new equity-financed investment in the U.S. has been taxed twice in most cases.
"First, the return on investment is taxed under the corporate income tax and then again under the individual income tax when received by individual investors as dividend payments or realized as capital gains," wrote Robert Carroll, senior fellow at the Foundation.
In 2008, an organization called Defend My Dividend was formed to try and protect the preferential tax treatment of dividends. The group is a coalition of the American Gas Association and Edison Electric Institute representing 60 utility companies. Sempra Energy, parent of San Diego Gas and Electric Co. and Southern California Gas, is not a member of the group.
One company in the group is National Fuel Gas Co., an energy company involved in exploration and development as well as pipeline and storage. It recently increased its dividend payout to shareholders, something it has done for 40 consecutive years.
"We take significant pride in our dividend history and we are pleased that our balanced and integrated business model continues to generate value for our shareholders. The value of our dividend is enhanced by the favorable federal tax treatment that dividends currently receive," said CEO David Smith.
To dispel the belief that dividends only benefit the wealthy, the group commissioned Ernst & Young to do a profile of utility shareholders and how they benefit from the reduced tax on dividends.
Based on information from the IRS for the tax year 2007, 27.1 million tax returns had dividends qualifying for the lower tax rate from equity investments. Of those returns, 61 percent were filed by people over the age of 50 and 30 percent were from taxpayers over the age of 65.
In addition, 65 percent of the returns featuring dividend income were filed by people with incomes less that $100,000. And 36 percent were from taxpayers with incomes less than $50,000.
There is a proposal from the White House -- and introduced in the U.S. Senate by Finance Committee chairman Max Baucus -- that would extend the preferential tax treatment for people in those lower income categories. But, the Tax Foundation suggests that there are still other troubling factors.
"For example, even if the sunset of the 2003 reduction in the dividend tax rate is limited to families with incomes over $250,000, all households that hold dividend-paying stocks, regardless of their income, would be affected," said Carroll.
He says that the Patient Protection and Affordability Act of 2010, for the first time in history, will include unearned income in the calculation of Medicare taxes.
The Tax Foundation report also goes beyond the impact of the tax rate change on investors. It calculates the higher dividend tax rate, in conjunction with the high U.S. corporate tax rate, would make the United States the second highest among countries in the Organization for Economic Cooperation and Development.
The combination of the high dividend tax rate and high corporate tax rate raises serious concerns over the competitiveness for the U.S. as a place to locate a business," said Carroll.