Business Ethos Blog

Cashing Out

Dr. David Mielke, Retired Dean of the College of Business at Eastern Michigan University

 

I thought about talking about the fiscal cliff given the theoretical deadline of December 18th for the introduction of any legislation to be done before Christmas.  However, I don’t think it will happen and frankly I am very doubtful that anything will be done until next year.  There are some roadblocks that I see that will not be resolved:

1. There is a chance that Republicans will pass tax revenue increases, but as a result of deduction limits, not from rate increases.

2. President Obama introduced some “wild cards” that made things worse, specifically:

  a. Congress giving up its authority to approve any increase in the debt ceiling

  b. Additional spending—so called stimulus, that will diminish any budget reductions

  c. No proposal for cuts/changes in entitlements

  d. No suggestions for budget cuts

However, our main topic, “Cashing Out”, does tie directly to the implications of the expected tax increases. We have heard about the fiscal cliff and implications for individual tax rates and the income taxes for the wealthy.  However, there are other tax increases due–on dividends, capital gains and a new surcharge for Obamacare.  Specifically, the tax on dividends will increase from 15% to 39.6%, capital gains from 15% to 20%, and an additional 3.8% Obamacare tax on those with incomes over $250,000 and on all capital gains.  Given these dramatic changes what would you expect companies and individuals to do?  Good tax planning tells us to accelerate dividend payments to this year from next year and to consider selling stocks that have gains before the end of the year.  Is this the “Right Thing to do?”  Are companies and individuals manipulating the system to get tax advantages?  Let’s look at what is happening:

1. Some 173 companies have announced special dividends compared to 72 in the same period last year.

 

2. Some companies are accelerating dividend payments usually paid in January to December, including Costco, Wal-Mart, Leggett & Platt.

 

3. Recent volatility and relatively poor stock market performance could be due to people selling stock to take their capital gains.

 

4. There will be a distortion in tax revenues.  There will be an unexpected increase in taxes paid in the fourth quarter—people will be reporting higher dividends and stock sales and there will be lower tax revenues than expected next year when the rates go up.  So the estimates of tax rate increases bringing in higher revenues to help fix the budget deficit will not materialize.

 

5. We are seeing many U.S. companies that have billions of dollars in the banks borrowing money to pay those dividends and in many cases to fund pensions and to expand operations.  Why are companies borrowing despite having near record cash balances?  One reason could be the low interest rates, but the real reason is once again taxes.  The cash companies hold is overseas.  If they bring it back to the U.S. it will be taxed at 35%—the second highest rate in the developed world.  As examples, Whirlpool has 85% of its cash abroad, Johnson and Johnson, basically all of its $24.5 billion, Microsoft 87%—it is estimated that U.S. companies have about $1 trillion in cash abroad.

 

6. The corporate tax rates were discussed during the election with the possibility of lowering them.  This is not even on the table.  Result, U.S. companies will borrow here and keep the cash abroad.  This increases the probability that the companies will use the cash to invest abroad, rather than return it to the U.S. and invest here.

 

The end result, the inability to fix at least some of the tax system before the end of the year has provided companies and individuals the opportunity to avoid taxes.  Is this the “Right Thing to do?”  Yes, using the tax system legally certainly to one’s benefit is appropriate.  To some extent, we have already started going over the cliff.  Tax revenues will increase this year, be lower next year and in every instance of increasing rates, we will see more incentive to look for all loopholes possible to avoid future taxes.