The $78 Billion Question Affecting Dividend Stocks Today

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The $78 Billion Question Affecting Dividend Stocks TodayIt’s one of the biggest questions facing income investors today: What does the “fiscal cliff” mean for dividend stocks?

The term “fiscal cliff,” coined last year by Federal Reserve Chairmen Ben Bernanke, describes more than $500 billion in automatic tax hikes, including higher dividend tax rates; and $100 billion in spending cuts, as well as a debt limit increase.

(For more information about what the cuts mean for dividends taxes, you can see my latest write-up on the subject here.)

These measures would start Jan. 1, 2013, unless Congress comes to a compromise during the current lame-duck session. The Congressional Budget Office estimates that allowing the tax cuts to expire and going off the cliff would shrink theeconomy by 0.5% — or $78 billion — throwing the United States into a mild recession. It would also increase the unemployment rate to 9.1% by the end of 2013 from 7.9% today.

Whether or not Congress intervenes, investors are likely to see higher taxes on dividends and capital gains. But the good news is several factors suggest higher tax rates may not trigger the selloff in dividend stocks that some investors fear.

For starters, about half of dividend-paying stocks on the market are held in tax-sheltered accounts, which aren’t affected by higher dividend tax rates, according to brokerage firm Stifel Nicolaus. Much of the rest is held by hedge funds and institutions, which aren’t affected by the expiring tax cuts.

If history is any guide, then your high-yield holdings should weather any dividend tax increase in the long term. Historically, dividend stocks underperformed non-dividend payers for about six months after a dividend tax increase, according to Ned Davis Research Group.

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