BOSTON (AP) — What if one of your key sources of income were taxed at three times the rate you pay now?
That's a realistic possibility next year for high-income investors who own dividend-paying stocks or mutual funds. Dividend investors earning modest income and retirees who count on quarterly payouts could face a higher rate as well.
Investors have enjoyed historically low rates on investment income since 2003. But those will expire in January unless Congress and President Barack Obama reach a compromise first on taxes and government spending.
Failure to reach a deal would trigger higher rates on other income as well, plus automatic federal spending cuts. The combination could send the economy back into recession.
The prospect of higher rates on dividend payouts starting in January has left dividend investors, as well as dividend-paying companies, with plenty of news to track and what-ifs to consider.
Here's a look at the key moving parts:
NEW RATE REALITY?
Investors today pay 15 percent tax on most dividends and on capital gains, the profits from selling investments that have appreciated in value.
Unless Congress and Obama say otherwise, dividends will be taxed as ordinary income in 2013, the same as wages. So rates will go up depending on which income bracket a taxpayer is in.
For the highest earners, the dividend rate could jump to 43.4 percent. The president wants to restore a 39.6 percent ordinary income rate for top earners, up from the current 35. High-income taxpayers will also face a 3.8 percent tax on investment income to help pay for Obama's health care overhaul.
For those in middle tax brackets, dividend rates in the 20 to 30 percent range are likely.
The result is that middle-income earners could pay a dime or so more on each dollar of dividend income flowing into a taxable account. For high earners, it would be a quarter or so more.
Dividend rate increases could be smaller if congressional leaders and Obama agree on a compromise to raise the level to something less than what the president wants.
A tax bill can be delayed by holding investments in a tax-sheltered account. But many investors, especially those in higher tax brackets, don't rely exclusively on an individual retirement account or 401(k), in which earnings can grow tax-free.
BEATING THE DEADLINE
Dividend-paying companies want investors to be taxed minimally because it makes their stocks more attractive to hold. And many companies are reviewing their dividend policies, now that it appears investors could soon pay higher taxes.
Those companies face a decision: Keep dividend payouts at current levels and see how the budget talks go, or distribute special payouts in December, before taxes go up.
A few companies already are approving such unusual "fifth quarter" dividends, the term that Howard Silverblatt of S&P Dow Jones Indices uses for these payouts.
"If I'm in the top tax bracket, a company better have a great reason for paying me after Jan. 1 when my rate will be 43 percent, rather than the 15 percent I could have paid back in December," Silverblatt says.