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Investments That Benefit From The Repeal of Taxes on Dividends

- Alan Lavine and Gail Liberman

Who knows what the Bush tax cuts will look like after Congress gets a hold of it?

We might not pay taxes on dividend income. Or we may pay lower taxes on the income.

Regardless, the much needed tax break should benefit the following types of investments, according to a recent report in Standard & Poor's Outlook.

Stocks. Cash-rich blue chip stocks that pay healthy dividends should perform well. There would be a shift in investor sentiment to dividend-paying stocks away from start-up and small companies that don't pay dividends. Standard & Poor's says the payout rates on dividends probably would rise. That translates in higher quarterly dividend checks from the company. But there is no free lunch. If a company's profits suffer, it could cut dividends.

Preferred stock. Preferred stock is higher in the pecking order than common stock. Preferred stockholders get paid before common stockholders. They are next in line after bondholders to stake claim on a firm's assets. If preferred stock dividends are not taxed or are taxed at lower rates, preferred stock would be more competitive with bonds. Companies could issue more preferred stocks than bonds.

Investments that may not benefit from the proposes new tax law:

Real Estate Investment Trusts (REITs). REIT investors are stockholders in a company that manages property. The president's plan is for only dividends already taxed at the corporate level to get a tax break at the individual level. REITs are not taxed at the corporate level because they must pay out 90 percent of income as dividends. Thus, the law should have little impact on them. If anything, it could make other types of stocks more attractive.

Money funds. Money funds pay interest income. Investors would not get a tax break. However, if the fund issued what are called "equity participation shares" the money fund would be considered a stock. The income would be considered dividends and qualify for the tax break.

Municipal bonds. Tax-free bonds may lose some of their luster. Municipal bond issuers may have to raise rates to make the bonds more competitive with preferred stock and other dividend- paying investments. This could hurt prices on existing municipal bonds.


Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

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