Message Font: Serif | Sans-Serif
 
UnThreaded | Threaded | Whole Thread (9) | Ignore Thread Prev Thread | Next Thread
Author: markr33 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 120820  
Subject: If dividends were exempt from taxation Date: 5/23/2003 11:07 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Luckily the tax law passed earlier today is much saner than some of the initial proposals.

One big problem I perceived to exist in the initial proposal of full exclusion of dividends from tax is the apparently ease of converting short-term capital gains into tax-free dividends. Please correct me if I am wrong, but the following strategy appears to have been valid using that version of proposed tax law.

1) Have short-term capital gains in issue X.
2) Sell X and realize those short-term gains.
3) Buy Y just before it declares a dividend ("buy a dividend").
4) Receive dividend from Y.
5) Sell Y at a short-term capital loss.
6) Balance short-term capital gains from X with the short-term capital loss from Y. No tax due.
7) Dividend from Y. No tax due.

Is there some sort of fallacy here I missed ?
Print the post Back To Top
Author: wtam Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 65458 of 120820
Subject: Re: If dividends were exempt from taxation Date: 5/23/2003 11:51 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
i think you are right theoretically that is a valid strategy.

in the process you do expose yourself to some market risk and the transaction costs. sound theoretically, but tricky to implement. neat idea though.

Print the post Back To Top
Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 65460 of 120820
Subject: Re: If dividends were exempt from taxation Date: 5/23/2003 12:33 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Luckily the tax law passed earlier today is much saner than some of the initial proposals.

One big problem I perceived to exist in the initial proposal of full exclusion of dividends from tax is the apparently ease of converting short-term capital gains into tax-free dividends. Please correct me if I am wrong, but the following strategy appears to have been valid using that version of proposed tax law.

1) Have short-term capital gains in issue X.
2) Sell X and realize those short-term gains.
3) Buy Y just before it declares a dividend ("buy a dividend").
4) Receive dividend from Y.
5) Sell Y at a short-term capital loss.
6) Balance short-term capital gains from X with the short-term capital loss from Y. No tax due.
7) Dividend from Y. No tax due.

Is there some sort of fallacy here I missed ?


No fallacy, the problem is in the execution. Since most dividend yields are around 1%/year, but are paid quarterly, you would probably have to invest much more capital in Y to generate a dividend (and corresponding STCL) equivalent to the STCG realized in X.

Ira

Print the post Back To Top
Author: lorenzo2 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 65461 of 120820
Subject: Re: If dividends were exempt from taxation Date: 5/23/2003 12:55 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 2
Since most dividend yields are around 1%/year, but are paid quarterly, you would probably have to invest much more capital in Y to generate a dividend (and corresponding STCL) equivalent to the STCG realized in X.

There are many dividends much better than 1%: each of Altria (formerly Philip Morris), General Motors, Kodak, AT&T, SBC, and JP Morgan Chase are currently paying anywhere from 4% to 7%. But Ira's right - buying a dividend large enough to cover a STCG would require a large investment. You could ease that a bit by buying on margin, but that carries its own risks. Moreover, in recent years the volatility of the market (and the generally lower yields) makes this strategy difficult. The price of a stock should (theoretically) drop by the amount of the dividend when the stock goes ex div - but often normal day to day variations in price far exceed that amount.

Lorenzo

Print the post Back To Top
Author: wintbill Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 65462 of 120820
Subject: Re: If dividends were exempt from taxation Date: 5/23/2003 1:07 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
The price of a stock should (theoretically) drop by the amount of the dividend when the stock goes ex div - but often normal day to day variations in price far exceed that amount.

Wouldn't you expect an appropriate price drop on the date of record?

Bill


Print the post Back To Top
Author: lorenzo2 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 65464 of 120820
Subject: Re: If dividends were exempt from taxation Date: 5/23/2003 1:59 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
Wouldn't you expect an appropriate price drop on the date of record?

No, just on the ex div date. Example:

Altria Group (MO, formerly Philip Morris) paid a dividend of 64 cents/share on April 9. The record date for that dividend was March 14, which meant that the ex dividend date was March 12. (Ex div date is typically two business days before record date.) Sure enough, MO closed at $36.10 on March 11, and opened at $35.49 on March 12, a drop of 61 cents (roughly equal to the dividend). That's because if you bought MO on March 11 (before the ex div date), you would have received the 64 cent dividend on April 9. If you bought on March 12 (the ex div date), you wouldn't get that dividend, and so it's sensible that you would pay less.

The reason for the two day difference between ex div and record dates is that it takes three days to settle. If you bought MO on Mar 11, the trade would have settled on Mar 14. That's the record date - in other words, you own the stock at close of business and thus get the dividend...

MO pays one of the larger dividends among the Dow stocks, so the effect is pretty clear. The point of my earlier post was that a stock like AT&T (dividend 18.875 cents) often has day-to-day gyrations well in excess of its dividend amount. Indeed, T is up 74 cents today, the amount of its annual dividend.

Lorenzo

Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: markr33 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 65471 of 120820
Subject: Re: If dividends were exempt from taxation Date: 5/23/2003 3:32 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
No fallacy, the problem is in the execution. Since most dividend yields are around 1%/year, but are paid quarterly, you would probably have to invest much more capital in Y to generate a dividend (and corresponding STCL) equivalent to the STCG realized in X.

First of all, any equity that pays a dividend (MO for example pays 6% or so) could be used to generate the dividend income. Second of all, the capital need only be deployed for one day or so when the dividend is recorded. And third of all, limited capital could be used "serially" to gain dividends (and capital losses) from multiple equities.


Print the post Back To Top
Author: irasmilo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 65524 of 120820
Subject: Re: If dividends were exempt from taxation Date: 5/27/2003 4:03 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
Luckily the tax law passed earlier today is much saner than some of the initial proposals.

One big problem I perceived to exist in the initial proposal of full exclusion of dividends from tax is the apparently ease of converting short-term capital gains into tax-free dividends. Please correct me if I am wrong, but the following strategy appears to have been valid using that version of proposed tax law.

1) Have short-term capital gains in issue X.
2) Sell X and realize those short-term gains.
3) Buy Y just before it declares a dividend ("buy a dividend").
4) Receive dividend from Y.
5) Sell Y at a short-term capital loss.
6) Balance short-term capital gains from X with the short-term capital loss from Y. No tax due.
7) Dividend from Y. No tax due.

Is there some sort of fallacy here I missed ?


An article about the new tax law in today's NY Times indicates that you did miss something, or that the drafters had this dodge in mind. In order to get the reduced rate on dividends, you must hold the underlying stock for 60 days. I wonder how they're going to track all of this.

http://www.nytimes.com/2003/05/27/business/27PLAC.html

Ira




Print the post Back To Top
Author: markr33 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 65534 of 120820
Subject: Re: If dividends were exempt from taxation Date: 5/27/2003 5:10 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
An article about the new tax law in today's NY Times indicates that you did miss something, or that the drafters had this dodge in mind. In order to get the reduced rate on dividends, you must hold the underlying stock for 60 days. I wonder how they're going to track all of this.

http://www.nytimes.com/2003/05/27/business/27PLAC.html


This is very interesting. It seems that the tax dodge I described is pretty much (though not completely) negated. That is a good thing.

The other item regarding payments by short sellers in lieu of dividends may have some "unintended consequences" (as all changes in [tax] law do) -

1) Brokerage costs will rise (to keep track of which shares were loaned to short sellers), they will likely pass those costs on to their customers. Bad.
2) Margin accounts may change to allow people to prevent [some of] their holdings from being loaned to short sellers. Otherwise, people would just have to move their holdings a few days before a dividend is declared to their cash account and then back to their margin account afterwards (assuming margin requirements are met). Good and Bad.
3) Brokerages may eventually be forced to compensate people for allowing their shares to be loaned to short sellers (the way it works today, the brokerage gets all that interest, while the actual owner of the shares gets nothing). Good.

What the law probably should have included is a "new tax" on payments made in lieu of dividends equal to the top corporate tax rate (34%?) that would have been paid on those dividends had they been on real shares (rather than phantom shorted shares). This tax would be paid by the short seller, since he is "impersonating" the corporation by "issuing" new shares when he shorted the stock.


Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
UnThreaded | Threaded | Whole Thread (9) | Ignore Thread Prev Thread | Next Thread
Advertisement