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Dividend Tax Increase Could be a Boon for P2P Lending

by Peter Renton on November 13, 2012

My two favorite investments are p2p lending and high dividend-paying stocks. A good portion of my overall portfolio is in individual stocks that yield 4% or more. While I like the income I receive from dividends my favorite part about them is their tax treatment.

Come tax time I only have to pay 15% in taxes to the government. Unlike my p2p lending investments that are taxed at my standard rate. I am paying close to double the tax rate on my Lending Club and Prosper interest income compared to my dividend income. Then, of course, I have had some nice capital gains (long term) over the last couple of years that is also taxed favorably.

 The Looming Fiscal Cliff

But this favorable tax treatment may be coming to an end. Now, we have the looming fiscal cliff that the media loves to talk about. If Congress does nothing then the Bush era tax cuts will expire and we will be back to 2002 tax rates where dividends were treated as ordinary income. If this happens then dividend paying stocks will no longer have any tax advantages over other forms of income such as p2p lending.

Even though Congress still has several weeks left to pass some kind of extension or new tax law the effect of the fiscal cliff is already being felt. One company has decided to pay their dividend early so that it happens this year rather than next year. In the recent market pullback dividend paying stocks have been hit the hardest according to CNBC.

What it Means for P2P Lending

We are coming up on four years with interest rates hovering close to zero. Dividend stocks have been one of the bright spots for investors. Many blue chip companies pay attractive dividends and with favorable tax treatment dividend stocks have been very popular. But if that favorable tax treatment ends then many investors will actively look for alternatives. Not only that but investors who have a some of their portfolio in p2p lending could well allocate more money into Lending Club and Prosper.

Now, will it be a gold rush? No. Many investors will still be hesitant about p2p lending and decide to move their money elsewhere. But with the industry maturing I expect there will be many new investors coming on board regardless of what happens to taxes. New tax rates will just accelerate the process.

Of course, if Congress does nothing not only will tax rates go up but government spending will go down. That could well plunge the econcomy into recession. And that would be bad for p2p lending investors as we would likely see defaults rise. But that is a topic for another time.

What fo you think? Will a hike in dividend taxes impact your allocation to p2p lending. As always I am interested to hear your comments.

{ 13 comments… read them below or add one }

Bryce M. November 13, 2012 at 1:32 pm

I think that 33% tax on a 12% return is still better than a 15% tax on a 4% return.

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Peter Renton November 13, 2012 at 10:02 pm

I couldn’t agree more Bryce which is why I continue to take money out of the stock market and into p2p lending. But I also think it is good to diversify into different asset classes and one of the asset classes where I will continue to have money is dividend paying stocks.

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Dan B November 13, 2012 at 10:28 pm

Very true! You’ll get no argument from me on this one.

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Michael November 14, 2012 at 9:06 am

Death and taxes. For a dollar, after all taxes, you get to keep around 70 cents. For every dollar you put into an investment subject to risk you’ve already had it discounted 30%. To break even you need to make a 42% return not even including taxes. Most people will have a hard time doing that even over a 10 year span.

As much as I love to rant about taxes, I’ll spare everyone. I’d just like to point out that for people seriously saving for retirement, taxes on investments are the biggest barrier to success and I believe they need special treatment. They should not be taxed at earned income rates, or even at all. The government already utilized their ability to the tax that dollar once.

I would be in favor of a national sales tax and no other taxes. The beauty is in the simplicity. Everyone is pulling weight. If we start to have too much inflation, raise the rate. If we start to go into recession, lower the rate. People with more money spend more, people with less spend less. Exclude non-prepared food and housing. It’s fair. But that would make too much sense and would not allow politicians to leverage class warfare to buy votes. Considering 70% of economy is consumption I imagine it would be pretty easy to balance the budget which is currently running 1+ trillion deficits.

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Bryce M. November 14, 2012 at 9:22 am

You seem to suggest that the dollar you invest is somehow taxed twice. Only the gains are taxed.

DT November 15, 2012 at 2:30 pm

I have been pulling money out of stocks (including dividend paying stocks) and putting the money into P2P lending for over a year now. I currently have the lowest allocation of investment dollars in stocks in my life. I sleep better with less volatility in my investments. With over 5000 P2P loans, my high ROI changes at a snails pace, which I like.

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Peter Renton November 15, 2012 at 4:20 pm

DT, Great to hear. Yes, with 5,000 notes you will have a very steady portfolio gain every month.

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Dan November 15, 2012 at 7:47 pm

5,000 notes? Man, I’m envious and salivating. LOL I’ve got 1,600 and I thought I was doing well. Boo hoo. Good job DT

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Roy S November 15, 2012 at 10:16 pm

History tells us that the end result is the Republicans will compromise and raise the debt ceiling and raise taxes for promised spending cuts that never materialize. Based on this, I believe the economy will be in rough shape for the next few years. Dividends taxes are lower than normal income tax rates for the simple reason that the dividends are distributions of the net (NET OF CORPORATE INCOME TAXES) income of companies…which if you are averse to all caps, means that the corporations have already been taxed on the money at corporate income tax rates and thus the distributions are double taxed. And as stated above, the corporate income taxes will also be raised. Not only are your own taxes going to increase, but the corporations’ taxes will be increased. So, the corporations will have less money with which to distribute as dividends and most of your distributions will be heavily taxed, if you receive any at all. This basically means stock prices will fall and dividends will be scarce. Really, if the rates increase both times the companies would be better to try to prop up the stock price by not issuing dividends at all–for all you fixed income people, you’re SOL! Oh, and this assumes that the corporations will still be in business.

On the p2p lending side, you can basically expect more layoffs or reduction in hours. In order to avoid ObamaCare, employers have been cutting employee hours to part-time. So your Notes with lower wage income earners will probably suffer unless the borrower can secure a second part-time job. Of course, business will also be cutting costs in other ways, namely layoffs. Most people would like to keep their jobs, especially in the down market. But there are a few, like the Hostess employees, who are actively trying to lose their jobs. But job cuts happen in a down economy, and you can bet that will hurt your returns. Lending now, is probably not a good idea at all. One would hope that Prosper and LC are adjusting their UW models to compensate for the upcoming recession AND THE HIGHER RISK LENDERS ARE NOW TAKING!

Sorry, I’m such a Gloomy Gus, but I really don’t see any positive news for the next 2 or 3 years. I’m against Austerity, because the best course of action is for government to cut spending AND taxes. (Raising taxes now is the epitome of stupid. For anyone who knows anything about economics, some economists at Stanford have shown that government spending actually has a NEGATIVE multiplier effect. This means that every dollar the government taxes away reduces GDP. Though I actually think that if the tax rates were closer to 0%, there might be a positive multiplier effect. After all, if there aren’t any police or courts, there would be chaos, anarchy, theft and the like. But we are definitely at a point where an increase in tax rates would hurt the economy rather than help it.) Austerity generally calls for cuts in spending and increases in taxes. And if you read my parenthetical comments, you would see that tax increases are a bad idea.

So, that’s my humble opinion…

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Dan B November 15, 2012 at 10:57 pm

Hi Roy………….So does this mean that you’re not adding to your p2p position these days? Or are you, but at a reduced pace?

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Roy S November 16, 2012 at 12:30 am

I’m almost entirely out of stocks, and I’ve halted adding outside funds to my p2p position. It is a little more difficult to liquidate my p2p position, but I have considered it–or at the very minimum discontinuing re-investments and withdrawing the payments. My concern is two-fold: 1. another economic recession, and 2. inflation. I do see a commodity bubble, but I don’t trust the government to keep a stable dollar. Not that they have kept a stable dollar. I have seen calculations that we have been running 5 – 8% in inflation already (calculations not made by the government, obviously). So, I’m waiting to see when and where the bottom falls out. Then, with any luck, I can get in before everyone else starts seeing the real inflation and asset prices rise, thereby insulating myself a little from the effects of inflation. I’m not certain my strategy will work, but I’m at a loss as to what else to do.

Another concern is the US’s ability to borrow. I would prefer to see the debt ceiling actually be a debt ceiling for once. But I know they’re just going to vote to raise it, and they’re going to spend and borrow $1+ trillion for the foreseeable future. Eventually, buyers of US debt obligations are going to demand higher interest rates or stop buying them altogether. At that point, we’re going to see interest rates spike further hurting the US economy even further. And to think we can tax our way out of this problem is just delusional. (I did a calculation a year ago and found that if the US government were to confiscate the entire reported income of everyone making over $150,000 per year–an effective rate of 100%, meaning no one has any money left after taxes to pay bills, buy food or gas, etc.–that we still wouldn’t be able to close the annual budget deficit. So taxing the “rich” is a fool’s errand. If I remember correctly the budget would balance slightly below $100,000, but I don’t recall the exact figure at the moment.)

I hate to use this phrase, but I think the US is headed into a “perfect storm.” I am hoping I’m wrong, but I am very concerned.

What is your position, Dan? Do you believe my view is a little too dire?

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Dan B November 16, 2012 at 11:18 am

Compared to your scenarios, I suppose that my views would be categorized as downright giddy. :) You may of course be correct, though I don’t see the likely “perfect storm” scenario as you’ve described.

What I see happening is a continuation of what has been going on for the past 4 years, & that is the FED attempting to engineer a politically & socially palatable slow motion deleveraging. The printing of money, which is a quaint but inaccurate categorization, should be viewed within the context of an attempt to prevent a potentially accelerating price decline across all asset classes, be they stock, real estate etc. The whole “stimulating the economy” explanation is but a thin veneer masking this goal. The reason inflation has NOT skyrocketed in the past 4 years despite all this “money printing” is because there is a counterforce that is pushing all prices lower worldwide as the worldwide economy continues to slow down, continues to deleverage. In a nutshell, I see us muddling along, as we have been. I think it’s very likely that we will have a recession soon, but I don’t see it as being as severe as the 2008 one.

In terms of p2p investing, I continue to reinvest & slowly add to my position. Call me an optimist (for a change) but I expect my low to mid teen returns to remain unchanged for the foreseeable future.

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Bill S December 10, 2012 at 1:32 pm

Responding to Dan B’s comments on deleveraging read the Barron’s article on Ray Dalio and his view on America’s ‘beautiful deleveraging’

http://online.barrons.com/article/SB50001424053111904370004577390023566415282.html

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