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Subject:   Stock dividends
Date:   Fri, 19 Nov 1999
From:   Jennifer

My company went public in October. Right before the IPO, the board of directors declared a 5-for-4 stock dividend for shareholders of record a day before the IPO. The company lawyers say that for tax purposes, this "stock dividend" is actually a stock split, and therefore I won't be taxed on it. I've heard of cash dividends and stock splits, but never stock dividends that are treated like stock splits for tax purposes. How can I be sure I won't be hit with a big tax bill?

Answer

Hello Jennifer,

According to Internal Revenue Code Section 305(a), most stock dividends are non-taxable. You pro-rate your tax basis for the shares you previously owned over the new total shares. For example, if you had an $1,000 tax basis for 400 shares ($2.50 per share) and received a 25% stock dividend (100 shares), your new tax basis would be $1,000 / 500 = $2.00 per share. The holding period from your exisiting shares is also assigned to the shares received, like in a stock split.

Good luck!

Mike Gray

For more information about incentive stock options, request our free report, Incentive Stock Options - Executive Tax and Financial Planning Strategies.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.