At the end of last year, big tax hikes on dividends seemed a near certainty under the looming “fiscal cliff.”
But the surprise compromise reached in Congress means that most households will continue to pay no more than 15% tax on dividends and capital gains.
However, some higher-income investors will pay more:
- Households earning over $250,000 ($200,000 for singles) but less than $450,000 ($400,000 for singles) will continue to be taxed at 15% on dividends and capital gains. But because of the new 3.8% tax on investment income stemming from the heath care law, their taxes will actually go up and they will pay a combined rate of 18.8% on dividends and capital gains. (Their taxes will, of course, be higher on salary and other inflows deemed “ordinary income.”)
- Households earning over $450,000 ($400,000 for singles) will be taxed at 20% on dividends and capital gains. Coupled with the new 3.8% tax on investment income, their tax rate on dividends and capital gains will increase to 23.8%. Still, that’s a good deal considering they’ll pay 39.6% on salaries and other items of ordinary income.
Here are some quick facts to put the changes in context:
The new compromise will result in higher taxes for most households, according to the Tax Policy Center.
- 77% of workers will see a tax hike in 2013.
- It boils down to a $2,711 average tax increase for households earning from $200,000-500,000, and a $14,812 average tax increase for those making from $500,000-1,000,000.
Why do taxes on dividends and capital gains matter so much?
“Dividends are crucial to long-term returns,” says Charles Farrell, chief executive of Northstar Investment Advisors LLC in Denver and author of “Your Money Ratios.” “If we look back at the past 100 years in the stock market, dividends account for about 50% of investors’ total return. The other 50% is from price appreciation, or capital gains.”
Higher tax rates make investments in stocks and bonds less attractive, and reduce the returns earned by investors. That’s of concern when many investors are behind in saving for retirement and are still playing “catch up.”