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No and I apologize if my previous answer was confusing.  In both option A and B the company will pay the taxes.  So the company pays $2 million in both cases.  

the difference comes with the shareholders.  When the shareholder receives the dividend at the end of the year, he/she pays taxes at the dividend rate, now 15% in the US.  The difference really comes for those shareholders who are long term investors, and don't want the annual dividend payments.  If no dividend is paid, and the money is left in the company, and the company continues profit growth as you suggest, the individuals money grows without any of it being taxed.  Then say at the end of 10 years he sells, he then pays a 15% capital gains tax--but all of "his earnings" in the company have grown without him paying the 15% tax on the annual dividend.  So the 10 year holder not paying dividends, gets the full compounding effect on his portion of the earnings.  

If he invested in an identical company that paid the dividend every year, he would pay the personal tax on the dividend each year, and thus lose the opportunity to compound his gains on the portion paid in taxes.

This is less of an issue in the US than it was in the past.  So for example, 6 years ago the top federal income tax for individuals for ordinary income was about 40%, and that rate also applied to dividends.  So this meant earnings were taxed at (using your example) 33% by the corporation,,,and then the dividend was paid after the corporate tax was taken out,,,,,and the dividend was taxed again at the 40% level.  So just to play that out, if my portion of the corporate earnings was $10,000, the company was going to pay $3,333 in taxes to the government.  Then if the company was paying all after tax earnings out as dividends, I would get the remaining $6,667 paid to me as a dividend, and I would pay another $2,667 to the Federal Government.  So of my $10,000 portion of the earnings, I would be taxed twice and pay $6000 in total to the government, and receive only $4000--a combined tax rate of 60%.  And in New York or California, state tax would take at least another $667.

This "double taxation" effect on dividends caused companies to reduce their dividend payouts as a % of after tax earnings from something like 3.5% in the '70's to 1.2% in the early 2000 (from memory, but it was dramatic).  The view of companies was that it was better for the shareholder if the money was left in the company, not double taxed as a dividend, and then the shareholder could sell shares when he needed money, and the capital gains tax rate was lower than the ordinary income tax rate, so the shareholder did better.  Now at lower and equal dividend and capital gains tax rates of 15%, this is less of an issue, and companies are gradually starting to pay more in dividends.

by wchurchill on Sun Dec 24th, 2006 at 01:57:43 AM EST
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