Question

Suppose that Apple announced it would distribute $100 billion to shareholders in the form of cash dividends or stock repurchases. A tax-conscious investor in a high tax bracket would likely:

a. prefer a high dividend payout, because taxes on dividends can be deferred until the stock is sold.

b. prefer stock repurchases, because of the choice to sell shares back or not; plus, the tax rate on capital gains is capped and the tax is deferred until the stock is sold, which allows for tax-free compounding of returns until sold.

c. prefer a high dividend payout, since dividends received are not taxable to individual investors.

d. be indifferent with regard to whether Apple issues dividends or repurchases its stock.

e. None of the above.

Answer 1

A tax-conscious investor will hope that his/her income or returns aren't taxed highly.

If Apple has an option to distribute $100 billion in the form of cash or stock repurchases, a tax-conscious investor will prefer stock repurchases.

A share buyback represents an uncertain future return on which tax is deferred until the shares are sold.

Whereas in dividend payment, the returns in the current period are certain and are taxed.

Share repurchases can help produce higher capital gains, but investors won't need to pay taxes on them until they sell the shares.

Hence the answer is b. prefer stock repurchases, because of the choice to sell shares back or not; plus, the tax rate on capital gains is capped and the tax is deferred until the stock is sold, which allows for tax-free compounding of returns until sold.

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