A stock that pays you to hold it every quarter (and, in some circumstances, monthly)? That notion is popular among investors. Unsurprisingly, dividend stocks often draw a lot of capital.
Dividend stocks may soon become even more desirable despite how well-liked they currently are. You can thank Joe Biden for that.
Limits placed on buybacks
On August 19, the Inflation Reduction Act was ratified by President Biden. One of the most important laws in our history, according to him, was the legislation. That isn’t being dramatic at all.
One benefit of the plan is that it allocates $430 billion more than prior efforts to combating climate change. Additionally, it will provide Medicare the first-ever opportunity to directly negotiate the costs of the most expensive medications. The pharmaceutical business may experience disruption as a result of this transition.
The Inflation Reduction Act also has another clause that hasn’t gotten as much attention: starting in 2023, corporations will have to pay a 1% tax on stock buybacks.
Companies repurchase their own stock to provide cash to shareholders. The value of already-issued shares increases when shares are bought back. As the same amount of net income is distributed across fewer shares as a result of stock buybacks, profits per share might increase.
The increased tax will make it less likely for businesses to purchase back their shares. Some of these businesses may be encouraged to reward shareholders with bigger dividends, however.
Three examples
How may future business decisions be affected by the 1% tax on buybacks? Let’s examine three businesses that have a history of stock buybacks and dividend payments in 2022.
The first two quarters of this year saw Apple (AAPL -1.37%) buyback $44.6 billion worth of its own stock. Dividend payments of $7.4 billion were made to shareholders. Apple would have had to pay out $446 million in taxes on its stock buybacks if the Inflation Reduction Act had gone into force on January 1. Without incurring any more taxes, the corporation could have greatly increased its dividend distribution.
Another IT juggernaut with significant stock buybacks is Microsoft (MSFT -1.07%), which stands out. In the first two months of calendar year 2022, the business repurchased $15.6 billion worth of its shares. A $9.2 billion dividend was also handed out. If a 1% tax on those stock buybacks had been imposed, Microsoft may have chosen to boost dividend payouts instead.
In the first quarter of 2022, Amgen (AMGN -0.53%) repurchased more than $5.4 billion worth of its shares; no repurchases were made in the second quarter. Additionally, the large biotech spent almost $2.1 billion on dividend payments in the first half of the year. Again, if the upcoming tax on stock buybacks had been in effect, these sums might have easily been tilted further in favor of dividends.
Paying dividends
The new tax enacted under the Inflation Reduction Act: Would businesses actually be more inclined to increase their dividends as a result? According to a Tax Policy Center study, a 1% tax on share buybacks would raise company dividend distributions by 1.5%.
The decision to increase dividends rather than buy shares with additional cash has a few disadvantages for businesses. Once a corporation raises its dividend, lowering it later might enrage shareholders. This issue does not exist for stock buybacks.
Dividend taxes must also be paid by shareholders. Those tax rates are usually much higher than 1%. When choosing how to deploy capital, businesses may take this tax impact into consideration.
But this was a factor in the Inflation Reduction Act’s justification for including the additional tax. No matter what actions are taken by businesses like Apple, Microsoft, and Amgen, taxing stock buybacks will benefit Uncle Sam.
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