As outlined by the Administration's pitchmen, President Bush's new plan to eliminate the taxes investors pay on stock dividends looks like simplicity itself. But buried deep in the fine print are two startling conditions.
One could strike a blow against corporate tax shelters by forcing companies to choose between slashing their own tax bills and ensuring dividend relief for their investors. The second may ease pressure on tech companies to make such payouts--a step many would prefer to avoid How? By offering their investors generous new capital-gains tax relief, even if they retain earnings rather than pay dividends.
Here's how the first rule would work. Say a company didn't pay corporate income taxes last year, thanks to credits, shelters, and the like. The eligibility of the company's shareholders for dividend-tax relief would be limited. That, theoretically, should push CFOs to trim their reliance on tax breaks. In other words, the Administration is aiming for behavior modification via the tax code.
If enacted, the change will sharply reduce the value of all corporate tax benefits, ranging from envelope-pushing shelters to mainstream breaks such as the credit for research and development. Only earnings that are sheltered through the foreign tax credit would be immune from the curbs, according to Administration officials. "This is a big deal," says one congressional tax expert. "You are dramatically changing the economics of these tax preferences."
That would profoundly undermine the recent spurt in corporate tax avoidance. According to one estimate, among large companies, book earnings in 1998 exceeded taxable income by a staggering $287 billion--one good reason the idea is sure to generate an explosion of business opposition.
The second provision may provide relief to companies on whatever portion of earnings they retain, rather than pay out in dividends. In effect, the White House plan would give investors a capital gains break based on the level of a company's retained earnings. The result: a lower tax bill when investors sell their tech shares.
The proposals should give pause to investors who bought stocks as dividend plays in the euphoria over the Bush plan. And companies, for their part, may find that living with the new dividend tax break would be far more complicated than they ever imagined. By Howard Gleckman in Washington