The Best News Possible for Dividend Stocks

You’ve no doubt heard the Bush-era tax cuts have been extended.

After much sound and fury, Congress voted to extend the tax breaks to all Americans, including those in the top income brackets. The tax cuts were set to expire at midnight on Dec. 31, but will be extended through the end of 2012.

But did you hear the great news for income investors?

Lost in the headlines was some of the best news we’ve heard in a while. The 15% tax cap on qualified dividends and long-term capital gains was extended as well. And a tax rate of 0% on qualified dividends and long-term capital gains will apply for investors in tax brackets below 25% (those making less than $34,000 this year).

The deal puts an end to a debate that, if unresolved, would have seen Americans facing big tax hikes in 2011. It’s expected to give a major boost to the economy by providing consumers and businesses with more cash to spend.

Mark Zandi, the chief economist of Moody’s, upped his economic growth forecast for 2011 to 4% from 2.7% after the deal was announced. And what’s good for the economy can be good for dividend-paying stocks that use their higher profits to ratchet up payouts.

Billions more in dividends
Standard & Poor’s estimates investors with taxable accounts will pocket an additional $74.5 billion during the next two years under the extended 15% dividend tax treatment. Over the nearly 10 years that income investors will have enjoyed the reduced dividend tax rate, we’ll have raked in an additional $348.4 billion, says Standard & Poor’s.

The favorable tax rates also are anticipated to tip the scales in favor of dividend payouts and hikes, rather than share buybacks, when corporate boards are deciding on the best use of their cash hoards over the coming months. That should help lift the share prices of dividend stocks as the increasing payouts attract investor interest.
So the Bush-era tax cuts will be with us for at least two more years. Come the 2012 presidential election, however, it’s possible the rate cuts may be made permanent. At the very least, it will certainly be a hot-button issue during campaigning.

At that time, dividend stocks could see another pop. Until then, we get to enjoy the tax-advantaged income in the years ahead.

Remember, not all dividends qualify for the reduced dividend rate. Some, such as U.S. real estate investment trusts (REITs) and business development companies (BDCs), will continue to throw off income that’s taxable at your marginal income tax rate and won’t benefit from the new tax laws.

Securities that pay qualified dividend income include certain preferred shares, many foreign companies that trade as American depository receipts (ADRs), and most taxable U.S. corporations.

Action to Take –> The extension is probably best news for tax-advantaged funds such as the Eaton Vance Tax-Advantaged Dividend Income Fund (NYSE: EVT). The niche of these funds is to serve up income that qualifies for the reduced 15% rate.

With at least two more years of qualified dividends (and even longer if the cuts are extended permanently), their place in the market is more secure and appealing to investors.

P.S.: With the recent tax-cut extension, the playing field for income investing looks better than ever. If you want to earn a greater income stream in 2011, I invite you to read this memo about my High-Yield Investing advisory. With more than 30,000 subscribers, it’s among the most popular income advisories in the nation. Click here to read more.