7942 / How are dividends that are automatically reinvested taxed?

Some mutual funds automatically reinvest shareholder dividends under a plan that credits the shareholder with additional shares, but gives the shareholder the right to withdraw the dividends at any time. Even though the dividend is not distributed directly to the shareholder, it is credited to his or her account. Such dividends are considered “constructively” received by the shareholder and are included in the shareholder’s income for the year in which they are credited to the shareholder’s account.¹ The basis of the new shares is the net asset value used to determine the dividend (i.e., the amount of the dividend used to purchase the new shares).²

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1. Rev. Rul. 72-410, 1972-2 CB 412.

2. IRS Pub. 550; Treas. Reg. § 1.305-2.