Taxation Of Dividends

<div class="Section1">A stock split is treated in the same manner as a stock dividend.<a href="#_ftn1" name="_ftnref1">¹</a>&nbsp;Therefore, a stock split is generally a nontaxable event for the shareholder (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7509">7509</a>).&nbsp;The tax basis and holding period of the &ldquo;new&rdquo; stock received in a stock split is determined as discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7510">7510</a>.<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;305(a).<br /> <br /> </div></div><br />

<div class="Section1">Although dividends received or credited under a dividend reinvestment plan will be taxed as dividend income, the specifics depend on which of the two basic types of plans is involved.<div class="Section1"><br /> <br /> (1) If, under the plan, the corporation pays the cash dividends (that would otherwise be paid to the plan participants) to an independent agent who purchases shares of the distributing corporation&rsquo;s stock in the open market and credits them to the plan accounts of the individual shareholders, each participating shareholder is treated as though the cash had been distributed directly to the shareholder in a cash dividend.<a href="#_ftn1" name="_ftnref1">¹</a>&nbsp;Thus, the total amount of the cash dividend paid on the shareholder&rsquo;s behalf to the agent must be included by the shareholder in ordinary income as discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7502">7502</a>.The value of brokerage commissions paid by a corporation to an agent under a dividend reinvestment plan is a constructive dividend to each shareholder in the amount of each shareholder&rsquo;s pro rata share of the brokerage fees actually paid.<a href="#_ftn2" name="_ftnref2">²</a>&nbsp;The shares credited to a shareholder under the plan are treated as though the shareholder had made the purchase. Where the corporation does not pay the brokerage commissions to an agent purchasing the shares, commissions paid by the agent are treated as if paid by the individual shareholder (i.e., added to the shareholder&rsquo;s tax basis in the new shares), <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8049">8049</a>.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> (2) If, under the plan, the corporation (a) manages the plan itself and credits the accounts of participating shareholders with shares, or (b) pays the cash dividends to an independent agent who purchases shares (often at a discount) from the distributing corporation, each participating shareholder is treated as if the shareholder had received a <em>taxable</em> stock dividend, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7509">7509</a>. As a result, each participating shareholder must include as dividend income the fair market value (on the dividend payment date) of the shares credited to the shareholder&rsquo;s account in the plan <em>plus</em> any service charge paid to the agent (if one is used) out of the shareholder&rsquo;s portion of the cash dividend paid. Apparently, any service and administrative charges paid <em>by the corporation</em> need not be included in income by shareholders participating in the plan.<a href="#_ftn4" name="_ftnref4">⁴</a>&nbsp;The shareholder&rsquo;s tax basis in the shares credited to the shareholder&rsquo;s account is the fair market value of those shares on the dividend payment date, even though the shares may have been purchased at a discount or premium.<a href="#_ftn5" name="_ftnref5">⁵</a>&nbsp;The holding period of the shares credited to a participating shareholder&rsquo;s account begins on the day following the dividend payment date.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> If a service charge is paid to an independent agent out of the cash dividend under either type of plan, that service charge may be deductible by the participating shareholder.<a href="#_ftn7" name="_ftnref7">⁷</a> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8049">8049</a> regarding the deduction of expenses paid in connection with the production of investment<br /> income.<br /> <br /> A participating shareholder realizes no taxable income when the certificates are eventually received representing whole shares credited to the shareholder&rsquo;s account in the plan.<a href="#_ftn8" name="_ftnref8">⁸</a> Upon withdrawal from or termination of the plan, if cash is distributed to a participating shareholder in lieu of fractional share interests, the shareholder is treated as though fractional shares had been received and redeemed, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7512">7512</a>.<a href="#_ftn9" name="_ftnref9">⁹</a> If on withdrawal from or termination of the plan, fractional shares and/or whole shares are sold or exchanged on behalf of the participating shareholders, each shareholder recognizes capital gain or loss as though the shareholder had received and sold the shares.<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Rev. Rul. 77-149, 1977-1 CB 82.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; GCM 39482 (5-5-86).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Rev. Rul. 75-548, 1975-2 CB 331; Rev. Rul. 70-627, 1970-2 CB 159.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; Let. Rul. 7928066.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp; Rev. Rul. 79-42, 1979-1 CB 130; Rev. Rul. 78-375, 1978-2 CB 130; Rev. Rul. 76-53, 1976-1 CB 87.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp; Rev. Rul. 76-53, 1976-1 CB 87; Rev. Rul. 77-149, 1977-1 CB 82.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp; Rev. Rul. 78-375, 1978-2 CB 130; Rev. Rul. 70-627, 1970-2 CB 159.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp; Rev. Rul. 76-53, 1976-1 CB 87; Rev. Rul. 78-375, 1978-2 CB 130.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;&nbsp; Rev. Rul. 78-375, 1978-2 CB 130; Rev. Rul. 76-53, 1976-1 CB 87.<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp;&nbsp; Rev. Rul. 78-375, 1978-2 CB 130.<br /> <br /> </div></div><br />

<div class="Section1">The distribution of cash or scrip in lieu of fractional shares in a stock dividend will generally not, in and of itself, cause the entire stock dividend to be taxable, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7509">7509</a>.<div class="Section1"><br /> <br /> If a shareholder receives cash in lieu of a fractional share, the regulations state that the shareholder will be taxed as though the shareholder had actually received that fractional share and then the corporation had redeemed it.<a href="#_ftn1" name="_ftnref1">¹</a> Unfortunately, it is not clear whether all the redemption rules of IRC Section&nbsp;302 apply for the purpose of determining whether the cash is treated as having been received in a distribution to which IRC Section&nbsp;301 applies (i.e., as a dividend to the extent of the corporation&rsquo;s earnings and profits) or as proceeds from the sale or exchange of the fractional share (i.e., leading to capital gain or loss, depending on the holder&rsquo;s basis in the fractional share).<br /> <br /> But it is clear that if the corporation, with the approval of the shareholders, combines into whole shares the fractional shares due the shareholders, sells them in the market, and distributes the proceeds of the sale, the shareholders who receive the proceeds in lieu of a fractional share are treated as though they had received the fraction and made the sale themselves. Each such shareholder thus has a gain or loss to the extent of the difference between the cash received and the tax basis in the fractional share.<a href="#_ftn2" name="_ftnref2">²</a> Similarly, if a shareholder is allowed to elect to have the corporation sell scrip certificates that would otherwise be distributed in lieu of a fractional share and pay the proceeds to the shareholder, the shareholder is treated as having sold the scrip for a capital gain or loss to the extent of the difference between the cash received and the tax basis in the scrip certificate.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> If a shareholder does receive scrip certificates in lieu of a fractional share, the shareholder realizes no taxable income on the receipt.<a href="#_ftn4" name="_ftnref4">⁴</a>&nbsp;The shareholder will, however, be taxed on the sale or exchange of the scrip in the same manner as when the shareholder sells the whole shares of stock received in the stock dividend, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7509">7509</a>.<br /> <br /> The tax basis and holding period of fractional shares or scrip received in a nontaxable stock dividend are determined in the same manner as the whole shares received in that dividend, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7510">7510</a>.<br /> <br /> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a> for an explanation of the treatment of capital gain.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.305-3(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Rev. Rul. 69-15, 1969-1 CB 95. <em><em>See</em></em> the example on pp.&nbsp;23 of IRS Pub. 550.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; Rev. Rul. 69-202, 1969-1 CB 95; IRS Pub. 550, pp.&nbsp;22-23.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; Rev. Rul. 69-202, 1969-1 CB 95.<br /> <br /> </div></div><br />

<div class="Section1">Many dividend reinvestment plans offer participating shareholders an option to invest additional cash to purchase <em>at a discount</em> 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.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> 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.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   Rev. Rul. 78-375, 1978-2 CB 130.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   Rev. Rul. 76-53, 1976-1 CB 87.<br /> <br /> </div>

<div class="Section1">To the extent that a distribution paid with respect to its stock exceeds the corporation's accumulated and current earnings and profits, the shareholders will be deemed to have received a "return of capital."<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> When a shareholder receives a "return of capital" distribution, the shareholder's tax basis in the stock is reduced (but not below zero) by the amount of the distribution. The shareholder is not taxed to the extent that basis is reduced. Any excess of "return of capital" over the shareholder's tax basis in the stock is generally treated as capital gain.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 301(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   IRC §§ 301(c), 316.<br /> <br /> </div>

<div class="Section1">If a shareholder acquires stock warrants or other stock rights of the distributing corporation in a nontaxable stock dividend distribution (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7509">7509</a>) and either exercises or sells the warrants or rights, the tax basis in the &ldquo;old&rdquo; shares with respect to which the distribution of warrants or rights was made is generally reallocated (in the same manner as discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7510">7510</a> for stock dividends) between the old shares and the warrants or rights, in proportion to the fair market values of each on the date of distribution (not the declaration or record date). But if the fair market value of the warrants or rights is less than 15 percent of the fair market value of the &ldquo;old&rdquo; stock, the tax basis of the warrants will automatically be zero, unless the shareholder makes an irrevocable election to reallocate the basis of the old stock with respect to which the warrants or rights were distributed to <em>all</em> warrants or other rights received in the distribution.<a href="#_ftn1" name="_ftnref1">¹</a> Despite this, it has been held that where the subscription rights became valueless and the subscriptions received were refunded, no adjustment to the shareholders&rsquo; basis was required.<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> Apparently, if the warrants or rights are allowed to expire without exercise or sale, the tax basis of the warrants or rights is zero.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Treas. Reg. &sect;&sect;&nbsp;1.307-1, 1.307-2.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Rev. Rul. 74-501, 1974-2 CB 98.<br /> <br /> </div></div><br />

<div class="Section1">No. Without the transfer of the underlying stock, a gift or gratuitous assignment of future dividends will not shift the taxability of the dividends away from the owner of the stock.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> The bona fide sale of future dividends for good and sufficient consideration will result in the dividends being taxed to the purchaser and not the shareholder; but this will accelerate rather than reduce the shareholder's tax since the net sales proceeds must be reported by the shareholder-seller as ordinary income in the year of the sale.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   <em><em>See</em> Van Brunt v. Comm.</em>, 11 BTA 406 (1928); <em>Lucas v. Earl</em>, 281 U.S. 111 (1930).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   <em>Estate of Stranahan v. Comm.</em>, 472 F.2d 867 (6th Cir. 1973).<br /> <br /> </div>

<div class="Section1">A <em>stock dividend</em> is a dividend paid in shares of stock of the distributing corporation to its shareholders with respect to its outstanding stock. A distribution of stock to compensate the recipient for services rendered, for goods provided, or in payment of a debt is not made with respect to the distributing corporation's outstanding stock and, therefore, is not a stock dividend.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> A distribution of stock warrants (or other rights to acquire stock of the distributing corporation) is treated in the same manner as a stock dividend so long as the distribution of such warrants is made with respect to the corporation's outstanding stock (and not as compensation for services, etc.).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> A distribution of stock of the distributing corporation made with respect to outstanding stock rights or convertible securities of that corporation to the owners thereof will also qualify as a stock dividend.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 305(a); Treas. Reg. § 1.305-1.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 305(d); Treas. Reg. § 1.305-1(d).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.   IRC § 305(d).<br /> <br /> </div>

<div class="Section1">If a shareholder acquires stock in a <em>nontaxable</em> stock dividend (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7508">7508</a>), the shareholder&rsquo;s present tax basis in the &ldquo;old&rdquo; stock, with respect to which the stock dividend was paid, is reallocated between the old and the new shares in proportion to the fair market values of each on the date of distribution (not the declaration or record date).<a href="#_ftn1" name="_ftnref1">¹</a> If the stock with respect to which the dividend was paid was purchased at different times and for different prices, the shareholder may <em>not</em> use the overall average basis for purposes of this allocation. If the shareholder can adequately identify the various purchases, he or she may allocate the proportionate amount of the dividend stock to each lot and, with respect to each lot separately, reallocate the tax basis between the &ldquo;old&rdquo; and &ldquo;new&rdquo; shares according to the fair market value of each. If the shareholder cannot adequately identify the stock in each lot, the dividend stock is matched to the &ldquo;old&rdquo; stock in the order in which the &ldquo;old&rdquo; stock was acquired (i.e., a FIFO tracing approach), and the tax basis of those &ldquo;old&rdquo; shares is reallocated between the old and new matched shares according to their fair market values.<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> The holding period of the &ldquo;new&rdquo; stock received in a nontaxable stock dividend includes the holding period of the stock with respect to which the stock dividend was paid (i.e., the holding period of the &ldquo;old&rdquo; stock is &ldquo;tacked&rdquo; (i.e., added) onto the holding period of the new stock).<a href="#_ftn3" name="_ftnref3">³</a> If the &ldquo;old&rdquo; stock was purchased at different times, the &ldquo;new&rdquo; shares must be allocated to the individual lots of the &ldquo;old&rdquo; stock by adequate identification or a FIFO tracing approach as discussed above.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;307;&nbsp;Treas. Reg. &sect;&sect;&nbsp;1.307-1, 1.307-2.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; Rev. Rul. 71-350, 1971-2 CB 176; Rev. Rul. 56-653, 1956-2 CB 185; I.T. 2417, VII CB 59.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1223(5);&nbsp;Treas. Reg. &sect;&nbsp;1.1223-1(e).<br /> <br /> </div></div><br />

<div class="Section1"><em>Stripped preferred stock</em> is stock with respect to which there has been a separation of ownership between the stock and any dividend on it that has not become payable, if the stock (1) is limited and preferred as to dividends and does not participate in corporate growth to any significant extent; and (2) has a fixed redemption price.<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> An individual who purchases stripped preferred stock generally must (while he holds the stock) treat the stock as though it were a bond issued on the purchase date with an original issue discount equal to the excess, if any, of the redemption price over the price at which he purchased the stock.&nbsp;This tax treatment also applies with respect to any holder of the stock whose basis is determined by reference to the basis in the hands of the purchaser (such as a donee or legatee).<a href="#_ftn2" name="_ftnref2">²</a> (<em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7650">7650</a> for an explanation of the treatment of original issue discount.)<br /> <br /> An individual who strips the rights to one or more dividends from stock described above (i.e., stock that is limited and preferred as to dividends, does not participate in corporate growth to any significant extent and has a fixed redemption price) and disposes of those dividend rights generally will be treated as having purchased the stripped preferred stock on the date of the disposition, for a purchase price equal to the adjusted basis in the stripped preferred stock.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> The amounts includable in gross income under these provisions are treated as ordinary income, and the basis of the stock will be adjusted accordingly.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> &ldquo;Purchase,&rdquo; for purposes of this provision, is defined as an acquisition of stock where the basis of such stock is not determined in whole or in part by reference to the adjusted basis of the stock in the hands of the person from whom the stock was acquired.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;305(e)(5).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;305(e)(1).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; IRC &sect;&nbsp;305(e)(3).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; IRC &sect;&sect;&nbsp;305(e)(2), 305(e)(4).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp; IRC &sect;&nbsp;305(e)(6).<br /> <br /> </div></div><br />