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We are just months removed from one of the worst years for corporate dividends on record. Uncle Sam is expected to take another big bite out of that income in 2011 in the form of sharply higher taxes. And yet dividend investing has rarely looked better.

This year through mid-June, there were at least 135 dividend increases or initiations among the companies in the Standard & Poor’s 500 Index () in May said it would increase its quarterly payout 10%, to 22 cents a share. Dental-products provider Patterson () in June announced it would initiate a quarterly payout of 10 cents a share. And consumer electronics retailer Best Buy () announced June 24 that it would raise its dividend 7%, to 15 cents a share.

If the economy continues to gather strength, analysts say, many more companies will likely gain the confidence to boost dividends this year.

So what has changed? Corporate balance sheets, which were squeezed during the recession, are once again brimming with cash. S&P 500 nonfinancial companies had a record $837 billion in cash at the end of the first quarter, up from $665 billion a year earlier, according to S&P.

Of course, there are plenty of head winds. The tax rate on qualified dividend payments, capped in 2003 at 15%, is set to expire at the end of this year along with some other Bush-era tax cuts. Absent congressional action, the top dividend tax rate will jump to 39.6% next year. It also could end up somewhere in between.

And BP’s () June 16 announcement that it was suspending its payout was only the latest reminder that a seemingly fat dividend doesn’t always pan out. Last year, there were 78 dividend reductions or suspensions among the S&P 500 companies, slicing a record $52.6 billion in payments, all told. But for investors looking to generate steady income, the alternatives to dividends don’t stack up well. With the Federal Reserve keeping its key interest rate at a historical low, the roughly 2% average dividend yield of the S&P 500 looks attractive relative to many bond and cashlike investments.

The average taxable money market fund, for example, offers a paltry seven-day yield of 0.04%, according to iMoneyNet, which tracks the funds. Bonds carry risks of their own and must be rolled over and reinvested when they mature.

The long-term case for dividend investing, meanwhile, remains sound. Some research suggests that companies tend to boost these payments ahead of significant increases in cash flow. And dividends often provide a cushion when stock returns sag. That can be especially valuable for income-focused investors, such as those looking to cover regular living expenses during retirement.

Such investors shouldn’t rely on stock-price appreciation to pay the bills, says Josh Peters, the editor of the Morningstar DividendInvestor newsletter, because “those capital gains won’t always materialize when you need them.” He says now is “a good time to look for good dividend yields.”

With the payout picture brightening, some investors are following that advice. F. Courtney Mallinson Jr., 63, of Alexandria, Va., a few weeks ago boosted his position in the iShares Dow Jones Select Dividend Index () exchange-traded fund, which holds about 100 dividend-paying stocks.

Thinking about retirement in a few years, he says, “I’m looking to augment my pension and Social Security with investment income, and don’t want to depend on bonds.” With a broadly diversified dividend-focused fund, says Mallinson, a marketing manager for a telecom firm, “I just hold on forever.”

With some careful decision making, investors can exploit today’s favorable dividend climate without getting burned.

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