Crafty bosses like Steve Jobs and Warren Buffett don’t let their companies declare dividends.
That’s because these payouts get clobbered by taxes. At the moment the U.S. federal tax rate on dividends is 15 per cent, but the rate is set to triple next year.
The smart way for a corporation to pay out loose cash is with share buybacks. So the $10-billion (U.S.) buyback part of Apple’s announcement today is Jobs-smart. The $10-billion annual dividend, to begin this summer, is dumb.
Why is Apple initiating quarterly payouts? Because the mob wants it. Evidently the stock has been doing well in the past six months not just because iPhones are selling but because experts have been anticipating this big dividend announcement.
But Steve Jobs was not one to let popular fashion, on Wall Street or elsewhere, tell him what to do.
Michael Dell is another entrepreneur who would rather not let the clamour for quarterly payouts get in the way of intelligent financial management. Dell Inc. generates a lot of cash but does not pay it out. If you own this stock and you need a little cash to live on, you do what the founder does: sell a few shares, paying only capital gain taxes.
Berkshire Hathaway hasn’t paid a dividend since Buffett took control 47 years ago. The company generates a mountain of cash from its insurance and industrial operations. It is going to pay that cash out with a share buyback program.
There are a handful of other big, cash-generating companies that follow the Jobs-Buffett-Dell line of thinking on how to make shareholders better off. Among them: Symantec, the computer security firm, and AutoZone, the retailer of car parts.
Bill Gates is not stupid. What’s he doing letting Microsoft pay dividends? It doesn’t cost him anything. He’s a full-time philanthropist now, and his giant foundation doesn’t incur income tax on the Microsoft dividends piling in.
For the 2012 tax year, the federal rate on most cash dividends is 15 per cent and so is the rate on long-term capital gains. But taxpaying shareholders are still better off when their corporations disburse cash via share buybacks rather than dividends. They owe tax only if they sell some shares, only to the extent they have gains on those shares and only if they don’t have a capital loss carry forward to absorb any gain.
Next year the divergence between dividends and long-term gains is destined to get wider, absent any agreement between President Obama and Congress on extending the Bush tax cuts. Dividends will be taxed as ordinary income at rates up to 39.6 per cent. The rate on long gains goes to 20 per cent.
Then there are surtaxes. Beginning next year, Obama’s 3.8 per cent surtax on investment income kicks in for people with adjusted gross income over $250,000. There’s also a clawback on itemized deductions that effectively adds 1.2 percentage points to the tax bracket for most taxpayers.
All this adds up to a 44.6% maximum federal rate on dividends and a 25% rate on long-term gains.
Moral: Own Apple in your 401 (K) or IRA (In Canada, the equivalent is the RRSP). If you have money outside your tax-deferred accounts, invest it in stocks like Dell and Berkshire.
William Baldwin has been a journalist for 36 years, and was editor of Forbes magazine from 1999 to 2010. A federally-authorized tax practitioner in the United States, he graduated from Harvard in 1973 with a degree in linguistics and applied math.Report Typo/Error