Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend Tax Reform Could Reshape Income Portfolios in 2026
Transcript
- Lucas: So there's a policy conversation happening right now, mostly under the radar, that could fundamentally change how we think about dividend portfolios. And it's not about which company is raising its payout next quarter. Luna: What is it? Tax policy? Lucas: Exactly. There's a growing push in Washington to align dividend taxation more closely with capital gains rates. Right now, most dividends are taxed as ordinary income — top rate around 37 percent, plus the net investment income tax. But there's a bill floating around that would treat all dividends like qualified dividends, taxed at the long-term capital gains rate, which tops out at 20 percent. Luna: That's a huge spread. Seventeen percentage points difference for someone in the top bracket. Lucas: It is. And it would change the relative appeal of high-yield stocks versus growth stocks overnight. Let's use a concrete example. Verizon, currently yielding about 6.5 percent. Altria, even higher, around 8 percent. Right now, every dollar of that dividend is taxed at your ordinary income rate. Under this proposal, it'd be taxed at the capital gains rate. Luna: So the after-tax yield on those stocks would jump significantly. That could make them a lot more attractive to taxable accounts. Lucas: Right. And that matters because we've seen a rotation this month — utilities and consumer staples have been strong, but the S&P 500 is up only 1 percent in the last five days, while the Dow is up 1.8 percent. The Russell 2000, which is more rate-sensitive, is up 3.4 percent. So there's already some movement toward value and income. Luna: And a tax change like this would accelerate that trend. But is there any real chance it passes? The political landscape seems pretty gridlocked. Lucas: It's a long shot in an election year, but not impossible. There's a package of tax extenders that's been stalled — things like the research and development credit, bonus depreciation. Some lawmakers are trying to attach the dividend tax reform to that vehicle. And then there's the Kevin Warsh factor. Luna: Warsh, the former Fed governor who's been in the news? How does he fit in? Lucas: Warsh has been floated as a potential Fed chair if there's a change in administration. He's known for favoring simpler, more efficient tax structures. And he's written about the distortion created by taxing dividends differently than capital gains. If he ends up in a policy role, that could give the idea more momentum. Luna: Interesting. So it's not just a Wall Street talking point — there are actual people in positions of influence thinking about this. Lucas: Exactly. Now, let's talk about what it would mean for specific ETFs. Take SCHD, which we've talked about before. It's up 2.5 percent in the last five days. It focuses on dividend growth and quality, not just highest yield. Under a tax-equalization regime, the after-tax return on SCHD would improve, but maybe not as much as a pure high-yield fund like VYM, which is up only 1.3 percent. Luna: Because VYM has a higher current yield, so the tax benefit per dollar is larger. But SCHD might still win on total return if its companies grow dividends faster. Lucas: That's the key tension. If you're in a taxable account, you'd want to consider whether the tax savings on high current yield outweigh the lower growth potential. And this isn't just theoretical — a study by the Tax Foundation estimated that equalizing dividend and capital gains rates could increase equity values by 3 to 5 percent, concentrated in dividend-paying stocks. Luna: That's a meaningful revaluation. And it would happen quickly if the market thought passage was likely. Lucas: Right. So the question for investors is: do you position for this now, or wait? If the probability is low, you might ignore it. But if you think it's 20 percent or more, then owning high-quality dividend payers with strong fundamentals — like Johnson & Johnson, Procter & Gamble, Coca-Cola — gives you downside protection either way. Luna: Let me play devil's advocate. What about the argument that dividends are double-taxed — first at the corporate level, then at the individual level? Wouldn't lowering the individual rate just make that distortion worse? Lucas: That's actually the counterargument from some economists. They'd prefer a corporate tax cut or a dividend deduction. But politically, lowering the individual rate is easier because it looks like a tax cut for individuals. And it doesn't require changing the corporate tax code, which is a whole other mess. Luna: Fair point. So if we look at the current yield curve — 10-year at 4.57, 2-year at 4.08 — the spread is 49 basis points, down from 49 last week. That's a fairly flat curve, which typically favors dividend stocks over bonds for income. Lucas: Right. And with the Fed funds rate at 3.62, there's no immediate pressure to cut. So the competition from bonds is real. That's why this tax reform could be a game-changer: it would improve the after-tax yield on equities relative to bonds, without the Fed doing anything. Luna: Before we go further, I want to say — if you're getting value out of these conversations, it really makes a difference when listeners chip in. Even a couple of dollars helps keep the show ad-free and independent. You can find us at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small thing that adds up. And it lets us keep digging into topics like this without any sponsor influence. Luna: Absolutely. So back to the portfolio implications — if this tax change happens, would we see a rotation out of REITs and other structures that already get preferential tax treatment? Lucas: That's a great question. REIT dividends are mostly taxed as ordinary income, same as regular dividends. But some REIT dividends are considered 'return of capital,' which is tax-deferred. If regular dividends get a rate cut, the relative advantage of REITs' return of capital feature diminishes. So you might see some rotation out of REITs into high-quality corporate dividend payers. Luna: What about international dividend stocks? Many foreign companies pay dividends that are eligible for the foreign tax credit, but the U.S. tax treatment would still matter. Lucas: Right. For U.S. investors, foreign dividends are taxed the same as domestic dividends. So if the U.S. rate drops, that benefit applies to foreign stocks too. But you'd still have currency risk and withholding taxes. So the net impact might be smaller. Luna: So overall, the biggest beneficiaries would be high-yield domestic stocks in taxable accounts. That's Verizon, Altria, AT&T, utilities, tobacco, maybe some consumer staples. Lucas: Exactly. And the big question is: are those stocks already pricing in some probability of reform? Verizon is up 3.4 percent in the last five days, which is more than the market. But that could just be the broader rotation into value. It's hard to disentangle. Luna: One more thing — what about the holding period requirement for qualified dividends? Currently, you need to hold the stock for 60 days within the 121-day window around the ex-dividend date. Would that change? Lucas: Under the proposed bill, they'd eliminate that requirement entirely. So all dividends would be considered qualified, regardless of holding period. That would make short-term dividend capture strategies more attractive, which could increase trading volume around ex-dividend dates. Luna: That's a interesting side effect. So we'd see more volatility around dividend dates. Lucas: Potentially. But for long-term investors, the main takeaway is this: if you believe there's a realistic chance of this tax reform passing in the next 12 to 18 months, it makes sense to overweight high-quality dividend payers, especially those with sustainable payout ratios and strong balance sheets. Because you'd get the income stream plus an eventual tax-driven valuation boost. Luna: And if it doesn't pass, you're still holding solid companies that pay a growing dividend. So it's a win-win, as long as you don't overpay. Lucas: Right. And that's the challenge — stocks like Procter & Gamble and Coca-Cola are trading at premiums. PG is at 144, up 1.4 percent in five days. KO is at 81, flat. They're not cheap on a P/E basis. So you have to be selective. Luna: This is a great topic to track over the summer as we get closer to the election and the tax extenders deadline. We'll definitely come back to it. Lucas: Agreed. In the meantime, keep an eye on the 10-year yield and the yield curve. If the curve steepens, that could signal a shift in growth expectations that might change the calculus for dividend stocks regardless of tax policy. Luna: Great point. Thanks, Lucas. Lucas: Thanks, Luna. Talk to you next time.