Dividend investors face year-end tax web

What if one of your key sources of income were taxed at three times the rate you pay now?

That's a possibility next year for high-income investors who own dividend-paying stocks or mutual funds. Dividend investors earning modest income and retirees who count on quarterly payouts could face a higher rate, as well.

Investors have enjoyed historically low rates on investment income since 2003. But those will expire in January unless Congress and President Obama reach a compromise first on taxes and government spending.

New rate reality? Investors today pay 15 percent tax on most dividends and capital gains, the profits from selling investments that have appreciated in value. Unless Congress and Obama say otherwise, dividends will be taxed as ordinary income in 2013, the same as wages. So rates will go up depending on which income bracket taxpayers are in.

For the highest earners, the dividend rate could jump to 43.4 percent. The president wants to restore a 39.6 percent ordinary income rate for top earners, up from the current 35. High-income taxpayers will also face a 3.8 percent tax on investment income to help pay for Obama's health-care overhaul.

For those in middle tax brackets, dividend rates in the 20 percent to 30 percent range are likely. Middle-income earners could pay a dime or so more on each dollar of dividend income flowing into a taxable account. For high earners, it would be a quarter or so more.

Beating the deadline. Dividend-paying companies want investors to be taxed minimally because it makes their stocks more attractive to hold. Those companies face a decision: Keep dividend payouts at current levels and see how budget talks go, or distribute special payouts in December - what Howard Silverblatt of S&P Dow Jones Indices calls "fifth-quarter" dividends.

Companies have another week or two to decide whether to make special payouts, he said. Dividends are typically distributed a few weeks after the payout is announced.