Question

Today dividends are taxed as ordinary income (an investor’s marginal tax rate which is on average 25%), while long-term capital gains are taxed at 15%. Suppose Congress is considering a law that will tax long-term capital gains and dividends at 25%. How will this affect a firm’s choice of dividend policy? Specifically, a. how will this affect firms that are paying dividends AND firms that are not paying dividends? (5 pts) b. how will this affect investor preferences relative to today? (5 pts)

Answer 1

Hello

Analyses of Questions Information

Current Rates

Dividends @ 25% and LTCG@ 15% then in this case firms prefer not to declare dividend or to declare minimum and focus on increase in price of share which includes retained earnings

After Amendment

Dividends and LTCG @25% then it will indifferent for investor from tax point of view but here investor will focus on dividend declared funds

a) The firms which already declare dividend will declare maximum amount of income as dividend due to indifferent point of tax liability and will keep the preference of investor

The Firms which doesn't declare dividend at all due to wealth maximisation of investor will distribute maximum income in the form of dividend

b) As far as current rate is concerned the investor preference will be wealth maximisation and low dividends but they will change their preference from accumulation of income to distribution of income as and when the prospective tax rates will be applicable