The proposal to end the double taxation of dividends is a great idea, but it won't end taxes on dividends for retirement plan participants - whether they are in traditional defined benefit plans or 401(k)s and other defined contribution plans, individual retirement accounts, or even the president's proposed Employer Retirement Savings Account.
They ultimately still pay taxes on dividends, as Michael P. Barry, president of Plan Advisory Services Group, Chicago, pointed out in a commentary last month in Pensions & Investments.
The administration has to fix this oversight, but that could be complicated.
Under existing tax law, pension and 401(k) plans have a privileged position.
Unlike ordinary taxpayers, retirement programs don't pay taxes on dividends or any other gains from plan investments when earned.
As the law stands now, pension plan and 401(k) participants pay taxes on the distributions they receive. Those distributions include dividends that were earned by their plans' investments.
But individuals who receive dividends outside a tax-qualified plan won't pay any taxes on those dividends under the administration proposal.
Surely the administration didn't mean to exclude pension participants from the proposed dividend tax exclusion.
Fixing the proposal won't be easy. How do you track dividends earned by plan investments for many years to ensure they aren't ultimately taxed in distributions?
The administration could repeal the tax on any distributions, but that sweeping favor for retirees seems unlikely to pass, considering the tax revenue loss. The administration also could change the proposal to end the double taxation at the corporate end, by not taxing corporations for earnings paid out in dividends. That revision might be better in terms of economic benefit, but it might be a harder sell politically: It wouldn't seem to give the immediate tax relief to individuals, and wouldn't of course give any new relief to pension participants, even though all investors would be better off with a lower corporate tax.
Somehow, though, the administration's proposal has to be changed to avoid unfairly taxing pension participants.