Double Taxation

Q Are stock dividends really taxed twice? — C.K., Richmond, California A They are, indeed. To understand how, imagine that the Tattoo Advertising Co. (ticker: YOWCH) generates $100 million in sales, and after subtracting various expenses, keeps $20 million, which gets taxed. The U.S. federal corporate tax rate has recently been 35 percent and was reduced to 21 percent starting in 2018. Many companies shield much of their income, with some paying an effective rate in the single digits — or lower!

Tattoo Advertising can do many things with its post-tax earnings. It can buy more equipment, hire more workers, pay dividends to shareholders, buy back and retire some of its own shares (which boosts the value of remaining shares) and so on. Any dividends it pays, though, are generally considered taxable income for shareholders. That’s how dividends get taxed twice.

The double taxation is why some investors prefer to see a company using its money to build more value for shareholders without paying out dividends. It’s also why some companies opt to repurchase shares, rewarding shareholders in a taxfree way. Repurchasing shares is wasteful, though, when a stock is overpriced.

Q Where does the money go when a stock falls in value? — S.R., Columbus, Indiana A No one necessarily gains directly when a company’s stock price drops.

Imagine you own shares of Porcine Aviation (ticker: PGSFLY) and its shares drop 10 percent one day. You haven’t technically lost any money, unless you sell the stock. (After all, they could rebound.) The shares are less valuable, though, because the market views them as less valuable due to some development or news. A stock’s price typically just reflects the last price someone was willing to pay for it. Want more information about stocks? Send us an email to foolnews@fool.com.