Accounting for Stock Splits

Corporations may not necessarily pay out cash dividends. Sometimes they use stock splits to accomplish corporate objectives, such as diluting the stock price (making it less costly and easier to buy). If you experience a stock split, understand how it impacts you financially and taxwise.

What is a stock split?

A stock split is designed to reduce the price of individual shares in order to increase their marketability. For example, say you own 10 shares of X Corp. and there is a 2-for-1 split. This means that for every share you held, you now own two shares; your 10 shares are now 20 shares. If the company wants to reduce the cost of its shares even more, it can use a 3-for-1 split (or any other split to achieve its goal).

A publicly traded stock that has split in the last 52 weeks will have an “s” next to the company’s name in the newspaper columns reporting stock trading.

Immediate tax impact

Stock splits are not taxable. Even though it may seem that you are receiving something of value because additional shares may be issued to you, in fact, your holdings in terms of value remain constant. For example, if your 10 shares of X worth $1,000 are split 2-for-1, your 20 shares are still worth $1,000.

However, the basis of the original shares must be divided among the total shares. If the original basis of the shares was $500, which is $50 per share, the new basis is still $500, but it is $25 per share. Basis will affect the amount of gain or loss you realize when you sell the shares.

The holding period is used to determine whether gain or loss on the sale of shares is long term or short term, which affects the amount of tax paid on the transaction. The holding period for the newly acquired shares is the same as the original shares. So if you acquired your original 10 shares on July 1, 2004, and receive a 2-for-1 stock split on August 1, 2007, all the shares have a holding period of July 1, 2004.

Reverse splits

Sometimes, corporations want to boost the value of their shares. For example, if a troubled company’s stock price drops too low, it can be “delisted” from the exchange on which it currently trades. It can use a reverse stock split to raise the current stock price.

A 2-for-1 reverse split means that if you originally held 10 shares of X Corp., you’ll have only 5 shares after the split. Each share will be worth twice as much as before the split.