Tax planning and compliance for investors
Free Online Guides
Rules for determining your basis and holding period for stock bought through a dividend reinvestment plan.
This page explains tax rules for dividend reinvestment plans (DRIPs). It covers the tax consequences of:
Note: Having your dividends reinvested through a dividend reinvestment plan may seem a lot like receiving a stock dividend. But the tax rules for stock dividends are different. When a company pays a stock dividend, all shareholders receive their dividend in the form of stock, not just the ones who choose to participate in a dividend reinvestment plan.
Many publicly traded companies maintain dividend reinvestment plans (sometimes called DRIPs). If you hold stock in XYZ and participate in a DRIP maintained by that company, cash dividends on your stock are automatically reinvested in XYZ stock.
Different companies design their DRIPs with different features. As a result, the tax consequences of different DRIPs can be slightly different. Here are some of the ways these plans may differ from one another:
When you are considering whether to participate in a DRIP, you should receive a prospectus that describes the features of the plan. The prospectus will point out advantages of participation, which may included avoiding brokerage commissions or buying stock at a discount. It will also point our possible disadvantages of participation. For example, if you decide to sell the stock you hold in the plan, you may not be able to do so as quickly as if you held the shares in a regular brokerage account.
The prospectus will also include a section describing the tax consequences of participation. If possible, you should rely on that discussion, and on information supplied by the company that maintains the DRIP, to determine your tax consequences. If the tax information in the prospectus isn't available, or isn't clear, the following explanation may be helpful.
The tax law treats you as the owner of shares you hold in a DRIP. The prospectus may refer to a trustee that holds your shares and administers the plan, but for tax purposes your stock is not held in trust. The administrator of the DRIP is merely acting as your agent, the same way your stockbroker does if you maintain a brokerage account. You do not have to report income when you take your shares out of a DRIP. If you receive cash from a DRIP, you will report gain or loss on the sale of shares to provide the cash.
If you participate in a DRIP that imposes a service charge, this charge is not included in the basis of shares you buy through the plan. Instead, it is an investment expense, which you may claim as a deduction subject to the limitations that apply to investment expense deductions.
When you participate in a dividend reinvestment plan, the amount of your dividend may not be the same as if you did not participate:
In general, you can rely on your annual Form 1099 to tell you the amount you must report as a dividend.
Your initial basis in shares you purchase through a DRIP includes:
This basic rule can spin out in different ways:
For shares that are received in lieu of cash dividends, your holding period begins on the day after the date of the dividend. If you make an optional purchase through a DRIP, your holding period begins on the day after the date the plan makes the purchase (not the day you send in your money). These rules are in keeping with the general rule for stock purchases: the holding period begins on the day after the trade date for the purchase.
Example: You participate in a DRIP maintained by XYZ and receive stock as a dividend on March 15, 1999. Your holding period begins March 16, 1999. If you sell on or before March 15, 2000, your gain or loss on the sale is short-term. If you sell on or after March 16, 2000, your gain or loss on the sale is long-term.
It's possible you will end up holding a fractional share that has a split holding period. For example, the plan may credit your account with 8.22 shares for the March dividend, and 7.15 shares for the June dividend. You would then own 8 shares with a holding period beginning in March, 7 shares with a holding period beginning in June, and a fractional share (37/100 of a share) with a holding period that is split between those two dates.
Figuring out your basis and holding period on any particular dividend reinvestment is usually not too hard. But if you reinvest dividends over a number of years, it may be very difficult to reconstruct the basis of your shares unless you keep records as you go along. It's a good idea to set up and maintain a good system of records for your stocks even if you do not participate in a DRIP. If you do use a DRIP, keeping good records is truly a necessity.
|That Thing Rich People Do||The fastest, easiest way to learn the principles of investing.|
|Our complete guide to Roth IRAs and Roth accounts in 401k and similar plans: choosing, creating, building and using these accounts.|
|Consider Your Options|
|A plain-language guide for people who receive stock options or other forms of equity compensation.|
|Equity Compensation Strategies|
|A text for financial advisors and other professionals who offer advice on how to handle equity compensation including stock options.|
|Capital Gains, Minimal Taxes|
|Tax rules and strategies for people who buy, own and sell stocks, mutual funds and stock options.|