December 8, 2012 in Business

Stock dividends being paid early to beat tax hike

Many companies borrowing to raise funds for payouts
Daniel Wagner Associated Press
 
Tax increase

If decade-old tax cuts are allowed to expire at the end of this year, dividends will be taxed like ordinary income, and the top rate for ordinary income will rise to 39.6 percent from 35 percent.

On the increase

Between Nov. 1 and Dec. 5, 349 companies moved up their dividends or paid special dividends, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indexes. That is higher than the 314 irregular dividends paid last year in all of November and December.

WASHINGTON – Companies are rushing special payments to shareholders to take advantage of lower dividend tax rates before they go up Jan. 1. But investors should beware: Not all special payments are created equal.

Some companies are borrowing a lot of money to make the payments. At others, the payments amount to corporate self-help, rewarding large shareholders who also sit on the board.

In addition to those companies, dozens have decided to move dividends that were scheduled for January into December – a no-brainer when you consider the tax advantage, said Howard Silverblatt, senior index analyst at S&P Dow Jones Indexes.

“Pay me in January or pay me in December: It makes no difference to the company,” Silverblatt said. “As a shareholder, if you pay me in January, you’d better have a good explanation for that.”

That’s because a January payment may nearly triple the tax rate that the highest earners must pay on dividends – to 43.4 percent from 15 percent, the rate in place since 2003.

If decade-old tax cuts are allowed to expire at the end of this year, dividends will be taxed like ordinary income, and the top rate for ordinary income will rise to 39.6 percent from 35 percent.

High earners will pay an additional 3.8 percent to help offset the cost of President Barack Obama’s health care overhaul.

Obama and Republicans in Congress are fighting over whether the top rate for ordinary income should increase. Republicans would prefer that the dividend tax remain at 15 percent but have not taken a hard line on it publicly.

Between Nov. 1 and Dec. 5, 349 companies moved up their dividends or paid special dividends, according to Silverblatt. That is higher than the 314 irregular dividends paid last year in all of November and December. Silverblatt expects the pace of early dividends to pick up if Washington keeps dawdling.

Many companies go beyond moving up ordinary payments. They are declaring special, one-time dividends to take advantage of the lower tax rate. Those special dividends can dramatically alter a company’s finances.

Normally, when a board declares a special dividend, it’s a sign of financial strength, experts say. That confidence can attract investors and boost the company’s stock price.

But these are not normal times. With so many companies declaring special dividends, professional traders have a warning for everyday investors.

“If they really thought this was the right plan, they would have done it already,” said Peter Tchir, who runs the hedge fund TF Market Advisors. He believes some companies are not considering the long-term costs of their decisions.

“People should scour these companies and see if they’re doing some damage to themselves on the credit side,” he said.

Many of the special dividends, it turns out, are not drawn from the proverbial mountain of cash that companies have been sitting on since the onset of the Great Recession.

Costco last month declared a special dividend of $7 per share, or about $3 billion. To pay for it, the company borrowed $3.5 billion. That caused Fitch, a rating agency, to downgrade Costco, though its rating remains relatively high.

Brown-Forman Corp., which makes Jack Daniel’s and other liquors, will pay for its $4 per share special dividend with a combination of cash and debt, executives said on a conference call with financial analysts. That amounts to $853.2 million. Brown-Forman did not respond to a request for comment.

The move was prudent, Chief Financial Officer Donald Berg said, because “we have a proven track record as strong stewards of capital.”

“Our recent dividend announcement reinforces our position as a company focused on delivering superior risk-adjusted returns for all of our shareholders,” Berg said.

For some companies, the special dividend appears to be a statement of opposition to possible tax increases.

“FOREGONE TAX RATES STIMULATE SHAREHOLDER PAYBACK,” blares the headline to a press release from National Beverage Corp., the company behind Faygo and Shasta soft drinks. “‘Patriotism’ – If Only We Could Bottle It!” the release concludes.

Later, when National Beverage set the size of its special dividend at $2.55 per share, totaling $118.1 million, it reassured investors that there would be no cash crunch. The decision was based in part on “a commitment by our largest shareholder to make available additional equity should the occasion develop,” Chairman and CEO Nick Caporella said in the announcement.

Caporella was referring to himself. He owns 74 percent of the company’s outstanding shares, either directly or through a company he controls. For him, the special dividend was worth $87.3 million before taxes.

Under the current tax rate, he will pay about $13.1 million on the dividend. By taking money out of the company early, Caporella saved for himself as much as $24.5 million that might have gone to the government. National Beverage declined to comment.

Tom Pemberton, of Pemberton Financial Planning, said it’s not unusual for companies to pay questionable special dividends to satisfy big shareholders – especially when they sit on the board.

“If I’m a large stockholder, I’m going to say, ‘Hey, let’s go ahead and have a special dividend,’ ” he said. He said ordinary investors shouldn’t “buy the stock or not buy the stock because of the special dividend.”

The market is rife with examples. The board of Opt-Sciences Corp., which makes special coatings for glass used in cockpits, declared a special dividend of 65 cents per share “to secure for the shareholders the benefits of the soon to be expiring current dividend tax treatment,” President and CEO Anderson McCabe said in the announcement. The family of one director, Arthur Kania, controls nearly 66 percent of the company’s stock.

Decisions like that are more common at small companies with relatively few shareholders, experts say. But big players sometimes get in on the act.

Oracle yanked into December a dividend of 18 cents per share, to replace the dividends it would have paid over the next three quarters. In the announcement, the company noted that “Oracle’s CEO and largest stockholder did not participate in the deliberation or the vote on this matter” – a reference to billionaire CEO Larry Ellison, who owns about 23 percent of the company’s stock. Oracle declined to comment.

Higher dividend taxes are likely, but they’re not inevitable. Until lawmakers and President Barack Obama have a deal, at least in theory, everything is on the table.

But the debate so far has focused on tax rates for the wealthy, with little noise about dividend rates. That’s why so many companies have concluded that dividend rates are likely to rise next year.

By issuing special dividends, companies are making boasts of financial strength, Silverblatt said, and those companies must be able to stand behind them.

“It’s a leap of faith to put out a large special dividend,” he said, “especially when there’s so much uncertainty out there.”

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