J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

4.6 Stock Dividends on Common Stock

If you own common stock in a company and receive additional shares of the same company as a dividend, the dividend is generally not taxable (see Chapter 30) for the method of computing cost basis of stock dividends (30.3) and rights and sales of such stock (30.4).

Exceptions to tax-free rule.

A stock dividend on common stock is taxable (4.8) when (1) you may elect to take either stock or cash; (2) there are different classes of common stock, one class receiving cash dividends and another class receiving stock; or (3) the dividend is of convertible preferred stock.

Fractional shares.

If a stock dividend is declared and you are only entitled to a fractional share, you may be given cash instead. To save the trouble and expense of issuing fractional shares, many companies directly issue cash in lieu of fractional shares or they set up a plan, with shareholder approval, for the fractional shares to be sold and the cash proceeds distributed to the shareholders. Your company should tell you how to report the cash payment. According to the IRS, you are generally treated as receiving a tax-free dividend of fractional shares, followed by a taxable redemption of the shares by the company. You report on Form 8949 and Schedule D (5.8) capital gain or loss equal to the excess of the cash over the basis of the fractional share; long- or short-term treatment depends on the holding period of the original stock. In certain cases, a cash distribution may be taxed ...