I'm not suggesting that taxes are or should be the only consideration when choosing a location for retirement.  In fact, I'd wager that most retirees land right where they've worked in the years before retirement.

Nonetheless, knowing which states are the worst for taxes might come in handy, especially if you're considering a change.

I wanted to point out this excellent post about non-deductible IRA contributions for two reasons.  The first is that it's valuable information that meets the common sense test.  The second reason is that it provides an introduction to Jim Blankenships's Getting Your Financial Ducks in a Row blog.  Jim's blog is a great source of financial planning information, particularly as it pertains to IRAs.  Check it out.

A key question looming on the minds of dividend investors and the stock market in general surrounds the taxation of dividends in 2011.

By way of context, dividends are taxed at the corporate level – as income, as well as at the individual level. This results in double taxation, and has long been fodder for philosophical debate over the fairness of the system. One school of thought holds that individuals should not pay taxes on dividends at all, because they’ve already paid as partial owners of the companies in question.

 In 2003, President Bush signed a tax reform bill into law that brought the dividend tax rates down from the standard wage tax rate.  For “qualified” dividends, taxes were paid at a rate of either 5% or 15%.  Lower income taxpayers saw qualified dividend rates drop to 0% in 2008-2010.  This rate structure mimics the long-term capital gains rates.  Note:  qualified dividends are paid on stocks held for all of the 120 day period around the ex-dividend date, which is the date on which the shareholder base is determined with regard to who will receive dividends.  In other words, if a shareholder owns the stock on or before ex-dividend date, he or she will receive a dividend for that period.

The 2003 cuts were significant, as the top tax bracket had dividend taxes cut from 35% to 15%.  Perhaps more importantly, the two lower brackets dropped from 10%/15% to not paying any taxes on dividends.  Unfortunately, the dividend tax rate is set to expire beginning January 1, 2011.  At that point, taxes on dividends will revert to the rates paid on wages.  Right now it is unclear what will actually happen at that point, however.

Simply extending the lower dividend rate seems like an option.  However, that would be considered a tax cut, which would require Congress to justify under PAYGO rules.  In short, the higher rates are factored into our federal revenue projections, and we’d have to pay for lower rates – even in the case of an extension – by cutting spending or raising revenue somewhere else.

Undoubtedly, any plan to raise taxes on dividends is designed to raise revenues to help pay for the dramatically increased government spending that has taken place over the last decade.  However, in its most extreme form, an unintended consequence could be to weaken the balance sheets of US corporations, such that they are less well equipped to deal with economic downturns.  That is because raising taxes on dividends could incent corporations to use debt instead of equity.  At least, it may dis-incent them to use equity, as the tax would be the same on interest payments as on dividends.

Furthermore, the recent health care bill already includes an additional 3.8% tax on investment income beginning in 2013.  This includes dividends.  So the rate is going up, one way or another.

What makes this a particularly stick situation is that the dividend tax decision impacts the wealthy as well as lower-income taxpayers.  Per a  Wall Street Journal report, the Tax Policy Center estimates that six million lower-income households will return to paying taxes if the Bush administration changes are simply allowed to lapse. Most Republicans, many Democrats, and President Obama have all stated that they believe dividends should be taxes at the lower capital gains rate, rather than standard income tax rates.

Bottom line

It is still anybody's guess as to how this will play out for taxpayers.  How will it play out for investors? Certainly, dividend stocks are more attractive under the current taxation plan than they were when dividends were taxed at the standard income rates.  However, the outsized returns achieved by dividend stocks that I highlighted in a previous blog post were  were largely gained under non-preferential tax rates.  Consequently, the argument for dividend stocks outperforming the market over the long-term remains strong, regardless of the direction of dividend taxes.  Within reason, of course.

I recently investigated a couple of tools that allow you to model your tax return for 2009 to get a ballpark feel for what your refund or obligation will be.  One tool is offered by Intuit's TurboTax.  Check out the Get Ready for Tax Time section on their home page, as there are a couple of other modeling tools that can give you a feel for the tax implications of certain life changes.

The Tax Estimator can be found on the Tax Tips & Calculators page of H&R Block's site.  This serves a similar function to the one offered by Intuit, and in fact the results were pretty similar with both tools.

Although my results were similar, there were some tax events that I could not model with these tools.  Those events are pretty significant for my taxes, so I wouldn't consider these highly effective for any but very straightforward tax situations.  Nonetheless, I think there is some benefit in the sense that it allows people to a) learn or reinforce the impact of things such as personal exemptions and tax credits, and b) do what-if scenarios with certain tax actions to determine the relative benefit of taking specific steps to reduce the tax bill.

Of course, in both cases the companies are trying to sell software for providing tax returns.  I'm not making any recommendations here, except to say that if you choose not to use a tax preparer, software can be extremely helpful.  If you are planning to purchase tax preparation software, I recommend doing some comparison shopping through sites like Upromise, Amazon, or even the shopping section of Microsoft's Bing.