US dividend tax doubts could drive swathe of special payouts

Uncertainty around the future taxation of dividends in the US could result in a slew of companies making special shareholder payouts before the year end.

Increasing the taxation of dividends is one of several measures that president Obama (pictured)  is expected to introduce in a bid to help deal with the country’s pending fiscal cliff.

Legg Mason US Equity Income fund manager Peter Vanderlee points out that dividends are currently taxed at 15% generally, and a potential increase in the investors’ nominal rate of tax could have massive implications for the market.

The issue is taking shape as a key battleground between the Democrats and the Republicans, where compromise or agreement seems the most distant.

‘No-one knows what the resolution will be, it is one of the biggest areas of uncertainty,’ Vanderlee says. ‘What I do think you will see in the US is a number of companies announcing special dividends before the year end and the impact will be noticeable.’

Several companies, including American Eagle, Sycamore Networks and DSW, have already announced special dividends and more are expected.

Vanderlee sees the uncertainty around the dividend tax as one of four factors currently holding back the market.

However, he says there does appear to be greater consensus, or at least a willingness to compromise, around the other three, with both parties seemingly agreeing that the existing payroll tax break will lapse on 1 January.

Similarly, the two parties are both against sequestration in January, worried about its impact on the military and although there are differences on both sides over potential upper bracket income tax hikes, there does seem scope for compromise, he says.

But despite the more thorny issue of dividend tax, Vanderlee remains upbeat about the prospects for US equities and in particular income stocks.