Introduction to Distribution of Corporate Stock to Shareholders

The related Sections that cover the topic of corporate stock distributions are Sections 305,306,307.

For the purpose of Sections 301(dividends),302(redemptions),303(redemptions for a decedent), and 304(sale of stock to a related corporation), “property” does not include:

  1. Stock in the company that’s making the distribution, or
  2. The rights to acquire stock (Section 313(a))

What this all means is that if a company makes a stock dividend, then the rules of Sections 301, 302, 303, and 304 don’t apply. Specifically, distributions of stock are controlled by Sections 305, 306, and 307. Under some circumstances, these three sections will go back and be subject to Section 301.

For example, if a corporation decides to pay out a stock dividend, each shareholder will own more stock, but they will each own the exact same percentage of shares. Because of this, the shareholders haven’t been enriched by any amount, so as a general rule this isn’t a taxable transaction.

General Rule of Stock Dividend Distributions

Distributions of company stock or stock rights are not taxable under Section 305 unless one of the five exceptions under Section 305(b) applies. If one of the five exceptions applies, then the stock dividend will be taxable as a regular dividend.

Examples of Stock Dividend Distributions

2-for-1 or 3-for-1 stock splits are very common with publicly traded stock. These stock splits are almost always tax free because of the same reason mentioned above… the shareholder ends up with the exact same percentage of ownership as before the split.

This usually drives the price of the stock down, which is what management wants so that more investors can afford to purchase the stock.

What Happens to the Shareholder’s Basis?

The general rule under Section 307(a) is that you take the basis of the old shares, and spread it over both the old and new shares based on their relative fair market values.

 Stock Dividend Basis Allocation Example

  1. Timmy has old shares with a basis of $90,000 and a fair market value of $210,000
  2. The corporation distributes two shares of new for each share of old.
  3. The fair market value of the old shares after the distribution is now $70,000
  4. The fair market value of the new shares after the distribution is $140,000
  5. The basis is divided up like this:
    1. The old shares get $30,000
    2. The new shares get $60,000

This is the calculation:

  Basis FMV Percentage Spread Basis
Old 90,000 70,000 33% 30,000
New n/a 140,000 66% 60,000
Total 90,000 210,000 100% 90,000

 Exception to the Section 307(a) Basis Rule

  1. It only applies to stock rights
  2. If the value of the stock right is less than 15% of the value of the old stock, no basis is allocated to the stock right
  3. Because of this, the stock right has a basis of zero
  4. Shareholder may elect to allocate basis

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