The Holy Trinity for Investing to Maximize Your Dividends

By Stepleman, Dr Robert | Sarasota Herald Tribune, May 28, 2012 | Go to article overview

The Holy Trinity for Investing to Maximize Your Dividends


Stepleman, Dr Robert, Sarasota Herald Tribune


DUE TO THE PECULIARITIES OF federal income tax law, interest paid by corporations is an allowed deduction on their returns but dividends are not. Thus, for most investors, dividends are taxed twice, first at the corporate level and then at the individual investor level. This double taxation substantially reduces the after- tax dividend payment to the investor.

But -- also because of peculiarities of federal income tax law -- distributions of three classes of entities are taxed only at the individual level, not at the corporate level. Properly used, these can substantially increase an investor's cash flow.

The least known of the three types of companies are Business Development Companies, or BDCs, which Congress created to encourage the flow of public-equity capital to companies not publicly traded.

One part of that encouragement was that, as long as they distributed 90 percent of their taxable income to their stockholders, their distributions would not be taxed at the corporate level. (This is a simplification of the very complex federal rules.)

This means that BDCs' shareholders can have both the liquidity of a publicly traded stock and participate in illiquid private equity investments.

It's relatively easy to invest in BDCs, either by buying one or more of many individual BDCs, a BDCs exchange-traded fund or ETF (ticker: BDCS) or even a closed-end mutual fund (ticker: FGB). I'm mentioning these investments as examples, not as recommendations.

BDCs are best held in tax-deferred accounts, since their dividends, currently about 10 percent, are fully taxable. The stocks of BDCs can be quite volatile, as BDCs' underlying private company investments tend to be quite risky.

The second least known investment of the trio are Master Limited Partnerships, or MLPs. They are limited partnerships that trade on major exchanges just like the stocks of ordinary corporations.

Their business is usually related to the transport and storage of crude oil and natural gas, but one is an investment manager.

To be an MLP, a firm must satisfy complex IRS requirements, including that 90 percent of the firm's income must come from businesses like those just mentioned. …

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