Companies or mutual funds that earn profits will at times distribute a portion of those profits to their shareholders through cash payments called dividends. Dividends are only paid to shareholders who own the corporation’s stock, and are paid out of a corporation’s after-tax profits. Dividends are typically paid quarterly, coming in conjunction with earnings reports, but these payments can technically be paid at any point during the year. Additionally, dividends can be halted, as is occurring currently due to the pandemic, in the event of fiscal difficulties within a corporation.
Dividends are primarily held by older, middle-income Americans. Of the 25 million tax returns with dividends, 63% are from taxpayers age 50 and older, and 68% are from returns with incomes less than $100,000. Even within those individual brackets, the numbers continue to skew towards the higher end of age and the lower end of income – 32% are 65 and older and 40% earn less than $50,000 annually. (EY, The Beneficiaries of the Dividend Tax Rate Reduction: A Profile of Qualified Dividend Shareholders)
Income earned from the sale of stocks and other investments is called a capital gain. Capital gains can be long-term or short-term. For tax purposes, long-term capital gains are defined as income earned from investments held for more than one-year.
The long-term capital gains tax is a tax on growth in value of stock that occurs when individuals or corporations choose to sell the stock. The tax doesn’t apply to unsold shares or capital gains that have yet to be realized, so stock shares that appreciate every year will not incur capital gains taxes until they are sold. Additionally, the amount of capital gains tax can be reduced by capital losses that have occurred throughout the year. Capital losses result when a stock is sold for less than it was originally purchased for.
Currently, the capital gains and dividend tax rates are connected, and income earned under these provisions are not taxed as ordinary income. Instead, they are taxed at 0%, 15% or 23.8% depending on a taxpayer’s taxable income and filing status. The income brackets are: 23.8% tax for individual taxpayers with taxable household income over $434,550, at 15% for individuals with taxable household income between $39,376-$434,550, and 0% for individuals who make less than $39,375 a year.
Higher dividend tax rates directly lead to lower stock prices, which as a result causes less investment in jobs, as well as less competitive businesses. In one economic analysis, an increase of the top rate of the dividend tax by 5% to 25% would decrease a dividend-paying company’s stock price by 6%. (Barclays, 2012). Overall, this would limit the amount of capital companies have, hurting key investments in the workforce and stifling economic growth.