Wholesale Dividends: Good or Just Special?

NewImageA number of US companies (including Costco, for example) are rushing to pay out massive dividends before December 31, 2012 to beat the dividend tax hike that is pending. A quick refresher on dividend taxes in the US: Under George W., long-term capital gains and dividends were subject to a temporary tax break resulting in a maximum tax rate of 15% (compared to normal business and employment income subject to a maximum tax rate of 35%). This tax holiday was supposed to have expired December 31, 2010 but was extended for two years by President Obama. Politically, dividend and capital gains tax rates are important. Those with less-than-average wealth generally don’t care about these rates since that set of the population doesn’t usually own investment portfolios that generate capital gains and dividends. However, the wealthy really do care, and they’re the ones who contribute to political coffers. But let’s leave the political aspects aside since they can be all-consuming on their own.

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If you are a US company and you know the dividend tax holiday is about to expire, you would prefer to give your shareholders cash before December 31, 2012 so they would only pay the 15% tax rate. If you paid the dividend the next day, January 1, 2013, your shareholders would be subject to a maximum 40% tax rate (39.6% to be exact). That’s a big difference. Especially when your dividend payment is $675 million. What? Who gets dividends like that?? Well, the Walton family does. Yes—the founding family and controlling shareholders of Walmart. They own and control 51% of the shares of Walmart and have decided to trigger a one-time, special dividend of roughly $1.3 billion, of which their portion is roughly $675 million. Issuing the dividend by December 31, 2012 results in tax savings of about $166 million for the Walton family alone. That’s a big deal and smart tax planning.

In Costco’s case, the special dividend works out to about $7 per share. This is well above the normal dividend rate of about $0.14 per share and works out to a total of $3 billion. Interestingly enough, the very same day that Costco announced its special dividend, it also announced new debt offerings (meaning it will be borrowing from investors) of $3.5 billion. Do you see any connection between the two? Paying the dividend requires $3 billion in cash, but Costco needs that cash for day-to-day operations, so it borrows more cash.

Should we care? I think so. This is a clear case of tax policy driving economic decisions—maybe even bad economic decisions. In Costco’s case, the US Treasury will collect substantially less tax than if the dividend was paid a month later, and the interest cost on the new debt is tax deductible for Costco, which will decrease its taxable income for years to come. In my opinion, this is a clear case of a wealth transfer to the rich at the expense of the general US tax payer, or at least the expense of the US government. There are some potential arguments to justify such behaviour but I don’t find them compelling. I will chalk this up to a capitalism #fail.

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)