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)
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 and one-third shares. The one-third share is a fractional share. Since many companies don’t want the administrative burden of maintaining fractional shares, they’ll immediately sell the one-third 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 do not generally have tax implications until you see the shares, the amount paid out in cash for the fractional share is considered taxable income. The sale of fractional shares is reported on Schedule D of Form 1040.