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Tax Pain Is Only Starting for the Wealthy

Stocks in this article: MO BAC PFE

Richard Taylor, a principal at HLB Gross Collins, an Atlanta-based accounting and consulting firm, says the new health-care bill could lead to a quadrupling of taxes on what's currently assessed on dividends.

For the past seven years, qualified dividends have had a federal tax rate of 15%. In 2013, health-care reform will add an additional 3.8% Medicare tax to all dividends, interest, capital gains, annuities, royalties and rental income for joint taxpayers with adjusted gross incomes of $250,000 and single taxpayers with incomes of $200,000.

In addition, if the current tax law reverts back to the 2000 tax system and rate schedules at the end of 2010 when the Bush tax cuts expire, dividend income will no longer be taxed as a special category of income -- capital gains -- but considered ordinary income, Taylor says. This means that in 2013, federal taxes on dividends -- adding the higher income rate and Medicare tax -- could total 43.4%. When you factor in additional state taxes (typically in the range of 6%, but as high as 10%), dividends could be taxed as high as 49.4% or even more depending on where you live. In a best-case scenario, Congress could enact an alternate proposal that would only increase the top federal dividend tax to 23.8% in 2013.

Among popular dividend-paying stocks are Altria Group (MO), Bank of America (BAC), Pfizer (PFE), Verizon (VZ), Exxon (XOM) and General Electric (GE).

"Would investors shy away from dividend-paying companies and invest in those that pay no dividends?" Taylor asks. "This could drive down the value of some of the best companies in the country."

He says investors, who have long looked to dividend stocks as part of a conservative strategy, may need to rethink their game plan. With less focus on dividends, investors may seek out stocks that have a greater potential to appreciate, such as Google (GOOG) and Microsoft (MSFT).

The crackdown

Dodging taxes will be increasingly risky in the coming years. Obama is seeking more than $12.5 billion for the IRS in fiscal 2011, including a $300 million increase for enforcement.

In the IRS's recently released "data book" of 2009 statistics, it reported a 16% increase in audits for those earning $5 million to $10 million and an 8.5% increase for those with earnings of at least $10 million. For those making $1 million or more, 8% were audited, meaning the odds of additional scrutiny is one in 12. Those earning less than $200,000 a year now have about a 1% chance of being audited.

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