Rock bottom interest rates forced the yield-starved investors to look for alternate sources of income. Many of them poured money in the dividend paying stocks and ETFs.

But the dividend stocks have taken a hit of late, due to the concerns relating to potential tax hike next year. Currently the qualified dividends are taxed at 15% top rate, same as long-term capital gains rate.

If the tax cuts are not extended, long-term capital gains tax will revert to 20% but the dividends will be taxed as income, at rates up to 39.6%. Additionally, there may be a 3.8% surcharge on investment income for investors with higher incomes.

While investors can look for alternate sources of income like emerging markets bonds or municipal bonds if the taxes do go up, I do not think that the high-quality dividend stocks should be sold in anticipation of the tax increase, as they still represent long-term value.

Many dividend stocks are held in tax-deferred accounts or held by institutional investors and are not affected by the tax issues. Some are held by the foreign investors.

Further most dividend paying companies are large, mature companies with solid cash-flows and are likely to perform better than the broader market if the cliff materializes. So, the sell-off in the dividend stocks is not entirely justified.

Please share your thoughts.