Timing of Tax Payments

When the 1986 tax law was signed into law, equalizing tax rates on ordinary income and capital gains, some believed that all the tax disadvantages of dividends had disappeared. Others noted that, even with the same tax rates, dividends carried a tax disadvantage because the investor had no choice as to when to report the dividend as income; taxes were due when the firm paid out the dividends. In contrast, investors retained discretionary power over when to recognize and pay taxes on capital gains, since such taxes were not due until the stock was sold. This timing option allowed the investor to reduce the tax liability in one of two ways. First, by taking capital gains in periods of low income or capital losses to offset against the gain, the investor could now reduce the taxes paid. Second, deferring a stock sale until an investor's death could result in tax savings. Since the tax rates on capital gains have decreased relative to the tax rates on dividends since, this timing option should make capital gains an even more attractive option now.

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