It's Not Easy to Make Dividends Tax-Free
Complexity Imperils Bush's Proposal
By Jonathan Weisman
Washington Post Staff Writer
Thursday, January 9, 2003; Page A08
President Bush's proposal to stop taxing dividends would be so complex to administer that Democratic opponents predicted its demise yesterday and even House Republicans warned that the administration must prove its feasibility.
At first blush, the centerpiece of the president's $674 billion plan -- a proposal to exempt all investment dividends from taxation -- would appear to simplify the tax code. But Bush's proposal would impose significant new record-keeping and tax-calculation requirements, both on the corporations that issue dividends and the investors who receive them, accountants said.
Bush, in vowing to end what he called the double taxation of dividends, has proposed a complicated system under which dividends would be tax-free only if companies can show that they paid taxes on the original profits.
Under the plan, companies would have to establish "excludable distribution accounts," in which they would record only corporate income that has been taxed. Companies would have to track income that is fully taxed, partially taxed and untaxed and then inform shareholders what portion of their dividends is tax-free. Adding to the complexity, a company's tax payments one year would determine the tax status of dividends paid in the following year.
"Nobody has the foggiest clue how this is going to be done," said David Mangefrida, a partner in the national tax department of Ernst & Young LLP.
Many dividends would still be taxed, since many corporations are paying little or no federal taxes. For instance, CSX Corp., the freight railroad headed by Treasury secretary nominee John W. Snow, paid $262 million in dividends in 1999, although it paid no taxes in 1998. It paid $171 million in dividends in 2001, although it paid no taxes in 2000. Under the Bush proposal, all of those dividends would be taxable.
Dividends paid by many mutual funds, including bond funds and money-market funds, would continue to be taxed, as well as dividends from real estate investment trusts.
The plan amounts to a potentially sizable cut in capital gains taxes. That is because, under the plan, a company that decides to retain profits instead of paying dividends would tell its shareholders how much of their earnings that could have been paid out in tax-free dividends was kept by the company. When an investor sells that stock, the amount held back could be added to the basis, what an investor paid for the stock, thus reducing any capital gain on which taxes are due.
Even White House allies said they have questions that have to be answered. Rep. Jim McCrery (R-La.), a Ways and Means Committee member, said he has been assured by administration officials that the plan is feasible, although it would add complexity to the tax code.
But, McCrery said, the committee will almost certainly have to hold hearings before bringing any legislation to a vote, far different treatment than that given past Bush tax proposals.
"We are asking a lot of questions about complexity and will continue to ask the questions until we're satisfied it can be done and will not be just a ridiculous mess," McCrery said.
Pamela Olson, the assistant Treasury secretary for tax policy, said the proposal "is not as complicated as it sounds."
Olson said it would offer such an enormous tax advantage to shareholders that companies would quickly develop systems to track taxed profits and keep investors informed. The administration did consider simpler ideas, such as granting the dividend tax exemption to the corporation rather than the shareholder or simply declaring all dividends tax-free.
But, she said, neither idea had "much of a shelf life," in large part because of cost to the Treasury.
Democrats and opponents of the plan were blunt in their predictions. One senior tax aide in the House said corporate lobbyists have worked too hard to win tax breaks and loopholes to allow those victories to now actually penalize shareholders.
"When I saw the details, I decided the administration isn't serious about actually passing it," said Robert McIntyre of the organized labor-backed Citizens for Tax Justice.
A number of tax experts said the Bush plan could work, but it would not be easy. Jamie Dahlberg of Deloitte & Touche LLP said the 1099 tax form that details dividend income would have to look considerably different, with extra boxes detailing tax-free cash distributions, taxable distributions and a retained-earnings disclosures.
The Treasury Department must still detail how dividends from foreign companies would be treated and must draft rules to ensure that large holding companies cannot shuffle tax payments among its dividend-paying subsidiaries to maximize shareholder tax breaks.
Other "anti-abuse" rules would have to be drafted, for instance, to ensure that clever investors could not simply buy a stock the day before the company issues its dividends, said Robert Gordon, president of 21st Securities, which specializes in tax strategies for investors.
All of these problems can be solved, said Kenneth Kies, a prominent tax lobbyist and former congressional tax aide. But, he said, opponents of the plan, especially in the business community, will use the plan's complexity to try to kill it when it is formally sent to Capitol Hill.
"It is not as complicated as people will make it out to be," Kies said. "However, you will hear a lot of howls when this goes up there."
Staff writer John M. Berry contributed to this report. |
