A stock dividend occurs when a company pays out a dividend by giving you additional shares of stock instead of paying it out in cash. Usually, these dividends don’t need to be included in taxable income. The total value (basis) of the stock doesn’t change. Instead, the basis of each share changes.
Example: You purchase 9 shares of stock in a company for $10 per share, which means the total basis of your shares is $90 (9 X $10). Then, the company decides to pay a stock dividend of 1 share for every 3 shares that you own. This means that you receive 3 additional shares of stock, and you now own a total of 12 shares. After receiving the stock dividend, the total basis of your stock is still $90, though, because you didn’t pay for the additional 3 shares. Instead, the basis of each share that you own is now $7.50:
$90 (Total value) / 12 (Shares of stock you now own) = $7.50
Sometimes, it doesn’t work out as nicely as the above example. What if you own 10 shares of the company’s stock? If you receive a stock dividend of 1 share for every 3 shares you own, then the company has to give you 3 1/3 shares. The 1/3 share is a fractional share. Since most companies don’t want the administrative hassle of maintaining fractional shares, they’ll immediately sell the 1/3 share and send you a check.
Example: You purchase 10 shares of stock in a company for $10 per share, and the total basis of your shares is $100 (10 X $10). Then, the company gives you a stock dividend of 1 share for every 3 shares that you own. Because companies don’t generally pay out fractional shares, we’ll assume that you now own 13 shares of stock, and you received a check for $2 for the fractional share. The total basis is now $102, which is the total basis of the stock ($100) plus the cash that you received ($2).
The basis of the fractional share is:
$100 (Total basis before dividend) X $2 (Amount received for fractional share) / $102 (Total basis after dividend) = $1.96
Although stock dividends are usually tax free, the amount paid out in cash is considered taxable income. To report cash in lieu of a fractional share in this situation, make these entries on the Capital Gains and Losses Worksheet:
Column (a): Description of the foregone fractional share (for example, "1/3 XYZ Company")
Column (b): Acquisition date of the shares on which the dividend was paid
Column (c): Date of the stock dividend
Column (d): Amount of cash received
Column (e):Basis of the fractional share
For more information, see Fractional Shares.