7515 / How is a shareholder taxed if the shareholder participates in a dividend reinvestment plan?

(1) If, under the plan, the corporation pays the cash dividends (that would otherwise be paid to the plan participants) to an independent agent who purchases shares of the distributing corporation’s stock in the open market and credits them to the plan accounts of the individual shareholders, each participating shareholder is treated as though the cash had been distributed directly to the shareholder in a cash dividend.¹ Thus, the total amount of the cash dividend paid on the shareholder’s behalf to the agent must be included by the shareholder in ordinary income as discussed in Q 7502.The value of brokerage commissions paid by a corporation to an agent under a dividend reinvestment plan is a constructive dividend to each shareholder in the amount of each shareholder’s pro rata share of the brokerage fees actually paid.² The shares credited to a shareholder under the plan are treated as though the shareholder had made the purchase. Where the corporation does not pay the brokerage commissions to an agent purchasing the shares, commissions paid by the agent are treated as if paid by the individual shareholder (i.e., added to the shareholder’s tax basis in the new shares), see Q 8049.³

(2) If, under the plan, the corporation (a) manages the plan itself and credits the accounts of participating shareholders with shares, or (b) pays the cash dividends to an independent agent who purchases shares (often at a discount) from the distributing corporation, each participating shareholder is treated as if the shareholder had received a taxable stock dividend, see Q 7509. As a result, each participating shareholder must include as dividend income the fair market value (on the dividend payment date) of the shares credited to the shareholder’s account in the plan plus any service charge paid to the agent (if one is used) out of the shareholder’s portion of the cash dividend paid. Apparently, any service and administrative charges paid by the corporation need not be included in income by shareholders participating in the plan.⁴ The shareholder’s tax basis in the shares credited to the shareholder’s account is the fair market value of those shares on the dividend payment date, even though the shares may have been purchased at a discount or premium.⁵ The holding period of the shares credited to a participating shareholder’s account begins on the day following the dividend payment date.⁶

If a service charge is paid to an independent agent out of the cash dividend under either type of plan, that service charge may be deductible by the participating shareholder.⁷ See Q 8049 regarding the deduction of expenses paid in connection with the production of investment
income.

A participating shareholder realizes no taxable income when the certificates are eventually received representing whole shares credited to the shareholder’s account in the plan.⁸ Upon withdrawal from or termination of the plan, if cash is distributed to a participating shareholder in lieu of fractional share interests, the shareholder is treated as though fractional shares had been received and redeemed, see Q 7512.⁹ If on withdrawal from or termination of the plan, fractional shares and/or whole shares are sold or exchanged on behalf of the participating shareholders, each shareholder recognizes capital gain or loss as though the shareholder had received and sold the shares.¹⁰