Question

3. Que Corporation pays a regular dividend of $1 per share. Typically, the stock price drops by $0.84 per share when the stock goes ex-dividend. Suppose the capital gains tax rate is 18%, but investors pay different tax rates on dividends. Absent transactions costs, what is the highest dividend tax rate of an investor who could gain from trading to capture the dividend?

Answer 1

when the stock drops investor lose 84 cents per share, but after tax the real loss is only 68.88 cents per share, because the loss is deductible (against capital gains) at 18%.

Therefore the highest dividend tax rate the investor could tolerate is 31.12% -- because at 31.12%, the after tax value of the $1.00 dividend is 68.88 cents, same as the after tax capital loss. If the dividend tax rate were higher than 31.12%, the investor loses.If the dividend tax rate were Less then 31.12%, Investor profits.

Therefore, Investors who pay a tax rate that is less than 31.12% could benefit from dividend capture strategy.

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