7516 / If a dividend reinvestment plan allows a participating shareholder to make additional purchases of stock at a discount, how is the purchase taxed?

Many dividend reinvestment plans offer participating shareholders an option to invest additional cash to purchase at a discount limited quantities of the distributing corporation's stock. If a shareholder elects to do so, he must include as dividend income on his federal income tax return the difference between the fair market value of the stock on the dividend payment date and the optional payment. (Apparently, this would normally be the amount of the discount.) A shareholder's tax basis in the shares purchased under this type of option is generally the shares' fair market value on the dividend payment date.¹

The holding period of stock purchased under the optional aspect of a dividend reinvestment plan begins on the day following the date the shares are purchased.²