October 18, 2012
Corporate Finance in the Shadow of the Fiscal Cliff
Posted by Christine Hurt

To catch-up:  In 2001 and 2003, Congress instituted a number of tax rate reductions that were set to expire at various times in the last decade.  Extended before, these reductions are again set to expire on December 31.  The media has focused on the impact on individual tax rates, which will increase.  More markedly, however, the rates for both capital gains and dividends will rise dramatically.  Specifically, dividend income would automatically be taxed as ordinary income, at the possibly new maximum income tax rate of 39.6%, instead of the rate for the past decade of 15%.  Plus, the ACA surtax on high earners will kick in for many investors, bringing the maximum dividend rate to 43.4%, almost three times as much as the rate now.

So, how will this change corporate behavior in the coming months?  Any estate tax planner will tell you (if they have time to talk at all) that for the next 2.5 months all they are doing is revising estate plans to address a possible change from the $5 million/person exemption to $1 million.  But are corporations scrambling as well?

This article seems to suggest no.  Corporations are not changing scheduled January dividends to December dividends, even though it would save their investors millions of dollars.  Even though corporations did make switches in the shadow of previous 2010 deadline.  So, do corporations know something we don't?  Do these big corporations, like Wal-Mart, have eyes and ears (and dollars) in Washington that tell them not to worry about the tax cliff?  Could Congress be ready to extend the rates after the election or even retroactively after the deadline?   Corporations don't have a deduction for paying out dividends, so corporations should be neutral, unless the higher rates increase their cost of capital.

Scholars could have years of projects out of observing behavior prior to these rate cut expirations.  Should investors change their behavior?  Perhaps investors should sell shares on December 31 in anticipation of a January dividend, hoping that the share price would reflect the high probability of the dividend.  Then, investors would pay the lower 15% on any capital gain, a rate that may also automatically increase to 28% on January 1.

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