Adam Ant, You've got the concept right. Let me give you the example we used to illustrate it to the Board at The St. Paul, and then it will be clearer why the technique has faded:
If The St. Paul earns a $1 dividend, but suffers a $1 capital loss, here is how it worked on an accounting basis. Only 15% of the $1 is taxed at, let's say, 40%. (I am ignoring state taxes as they vary too much in their treatment of dividends and their rates of taxation. The majority piggyback off Federal reports.) That means that 6 cents is taxed and 94 cents drops immediately to the bottom line as net income.
O.K., the $1 capital loss also comes out of income, but, since it reduces taxable income dollar for dollar, the Govt. eats 40 cents of the loss. So, in this case, the co. has a net loss of 60 cents to generate income of 96 cnets, or 36 cents to the good. Since there was net, net, no change in total assets, just a move in the income account, this is a big positive for the co.
The negatives are the risk of holding the stock while you take in the dividend. Obviously, if you earn a dollar in dividend but lose $5 in capital, that isn't a good tradeoff. <g>
What has changed is that the holding period, the main determinant of risk, has gone from 15 days to 45 days, greatly increasing total risk. Also, the dividend exclusion has been reduced from 85% to 70%, making the reward much less valuable. IMHO, that pretty much ruins the game.
BTW, you cannot buy an at the money put and get the exclusion, so selling calls or doing spread conversions is the best method of protection. |
