Tax planning tips for dividend stocks

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With domestic stocks well into the sixth year of a bull market, investors may want to shift their focus.

“We believe that that the lion’s share of a client’s equity holdings should be in large, cash-rich multinational companies,” says Greg Sarian of the Sarian Group at HighTower Advisors, a wealth management firm in Wayne, Pa. “We are in the mature stage of the economic cycle, so large-cap stocks may have better prospects now than small- or mid-caps.”

What’s more, sizable firms are likely to be dividend payers, and qualified dividends (including most dividends paid to investors) get tax breaks that can appeal to clients and to their relatives as well. “Single taxpayers owe 0% on qualified dividends as well as on long-term capital gains,” says Sarian, “as long as their taxable income is no more than $36,900 in 2014. For married couples filing jointly, the 0% rate is in effect up to $73,800 of taxable income. Strategies to use the 0% rate can be powerful tax planning tools.”


Stocks in the S&P 500 now yield almost 2%, on average, which may be reasonably attractive in today’s environment, while some well-regarded companies pay 3% or 4%.

Those yields might be even more alluring if they’re untaxed, but Sarian cautions that the so-called kiddie tax may limit use of the 0% tax rate by youngsters. Nevertheless, the kiddie tax doesn’t apply once someone reaches age 24, so dividend-paying stocks might provide untaxed income for clients’ children who are in graduate school or in the early stages of their careers.

The kiddie tax doesn’t affect clients’ parents, so retired seniors also may owe no tax on stock dividends. The income cutoffs are for taxable income, after deductions; thus, a married couple might have gross income of $80,000 or more and still qualify for the 0% tax rate on dividends.

“We see some clients giving appreciated assets to children or parents who can sell them and use the 0% rate on long-term capital gains,” says Sarian.

High-income clients won’t get the 0% tax rate but they still receive a break on qualified dividends because the tax rate is 15%, or 20% for those in the highest income tax bracket. “The 3.8% surtax on net investment income also may apply,” Sarian notes. Still, paying 18.8% or 23.8% on qualified dividends is less than the rate those clients would pay on taxable interest income, which could be taxed as high as 42.4%: the top regular tax rate of 39.6% plus the 3.8% surtax.


The tax tail shouldn’t wag the investment dog, as the saying goes, and Sarian sees much more than low tax taxes to like about dividend-paying stocks these days. “Dividends are increasing at many companies,” he says, and that may continue to be the case.

Inflation might heat up in the future, Sarian adds, and profitable companies with relatively little debt may be in a position to pay higher dividends. “Some of the companies that stand to receive more revenues in times of price increases, such as utilities and gas companies, are dividend payers,” he points out. “With such stocks, investors might have some protection from inflation.”

Higher dividends can lead to higher stock prices, and perhaps sales at low capital gains tax rates. In another scenario, appreciated stocks—including dividend payers—that are held until death now receive a basis step-up so heirs may be able to sell the inherited issues and owe zero income tax on any prior gains.

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

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