Shareholders Gorge on Payouts as Tax Hike Nears

Photograph by Jodi Jacobson

One boom, megabust, and sort-of-boom after they first went into effect, the expiration of George W. Bush-era tax cuts could goose the top individual dividend income-tax rates to more than 43 percent from the current 15 percent. This comes at a time when companies in the Standard & Poor’s 500-stock index lug about $900 billion in cash, a 40 percent jump since 2008 that has made them net suppliers of cash to the rest of the economy.

So then what better time than these waning days of 2012 for corporate managers—most often major shareholders themselves—to issue special, one-time dividends? In the spirit of the holiday season, too. It stands to reason that the closer the economy gets to falling off the fiscal cliff, the more likely boards would be to sign off on such payouts. The recent precedent for this was the final quarter of 2010, when companies raced to pay out extra cash on concerns that President Obama and the Republican Congress would not extend Bush-era tax cuts past the end of the year (that ball was effectively punted to the present).

A bit of history. Following Bush’s midterm electoral mandate 10 years ago, the president spent a chunk of his political capital on a 2003 tax plan (PDF) that slashed rates on corporate dividends. The rationale was that more take-home from equity dividends would be both a boon to investors (and their disposable income) hit by a bear market, and a way to realign the interests of corporations and households in the wake of Enron, WorldCom, and the unearthing of Wall Street rot. Market talking heads swore that the shareholder-friendly move would inspire a renaissance in investing for income.

In practice, investors displayed no particular rush to buy major dividend-payers. If anything, the 2008-09 meltdown induced a record number of blue chips to slash their payouts—unthinkable last resorts for the bulge-bracketed likes of General Electric, Pfizer, and Citigroup.

Today, however, corporate profits are at a record and the Federal Reserve-stoked Great Yield Hunt has sent tens of billions of dollars into junk bond and dividend-stock funds.

“Providing a special dividend to shareholders might be a good idea to consider in light of the election turnout,” says Joseph Perry, a partner in charge of tax and business services with accounting firm Marcum, which last month joined with broker Twenty-First Securities to urge companies to pay out early and often. “If you assume that dividend tax rates will go up next year, it is prudent to help your long-term shareholders before Dec. 31.” Perry says this can be accomplished either by paying out any cash dividends before year-end or by paying a stock dividend, which is generally not taxed until the stock is sold (thereby allowing investors to defer taxes until they sell their shares, and to take advantage of a long-term capital gains rate that even under the Obama plan would still be half the maximum dividend tax rate).

The calculus is a confusing one. Perry says that this time of year is normally when investors look to harvest losses, accelerate deductions, postpone income, and invest in companies that don’t pay dividends. “But for this year-end,” he says, “they need to do the opposite.”

The news tape increasingly has headlines from companies that get the need to shovel out excess cash while the shoveling’s cheap.

The Buckle, a retailer based in Kearney, Neb., just announced a $4.50 special dividend in addition to its usual 20¢ quarterly dividend. By grouping the moves together, the company is effectively rewarding its investors with a 10 percent dividend. Last month, Trinity Bank in Fort Worth said it would pay (PDF) a special, one-time dividend to shareholders of $1 per share in addition to its second cash dividend of 20¢. ”We don’t know what the dividend tax rate will be in 2013,” said President Jeffrey Harp in the statement. “But we know it will be higher. We can provide some tangible return now to our shareholders in the most tax-advantageous manner possible.”

And just ahead of the election, Commerce Bancshares of Kansas City, Mo., announced a special, one-time dividend of $1.50 a share in addition to its usual quarterly outlay of 23¢. “Given the potential significant increases in tax rates on dividends beginning next year, and our strong levels of capital, it is an opportune time to provide this special dividend distribution to our shareholders before the end of the year,” Chief Executive David Kemper remarked. Commerce also said that it would issue a 5 percent stock dividend in December.

According to Sandler O’Neill & Partners, the median percentage of community banks’ earnings paid as dividends was 26.4 percent in the third quarter, which is down from 44 percent three years ago.

Depending on your worldview, that is a good or bad thing. Good: Such financial institutions are profitable enough to comfortably return money to shareholders. Bad: They can (and should) pay out much more. Writ large, this gets at a bigger tension: The desire for bigger dividends competes with chastened corporations’ desire to hoard cash to avoid a 2008-09-like brush with death.

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