Euclid bought 500 shares of common stock five years ago for $50,000. This year, Euclid receives 20 shares of common stock as a nontaxable stock dividend. What is Euclid’s basis per share after this event? Assume instead that Euclid received a nontaxable preferred stock dividend of 20 shares. The preferred stock has a fair market value of $5,000, and the common stock, on which the preferred is distributed, has a fair market value of $75,000.

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Chapter1: Financial Statements And Business Decisions
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What are the tax consequences to Euclid from the following independent events?

  1. Euclid bought 500 shares of common stock five years ago for $50,000. This year, Euclid receives 20 shares of common stock as a nontaxable stock dividend. What is Euclid’s basis per share after this event?
  2. Assume instead that Euclid received a nontaxable preferred stock dividend of 20 shares. The preferred stock has a fair market value of $5,000, and the common stock, on which the preferred is distributed, has a fair market value of $75,000.
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Provisions of section 305 are based on the equivalent interest concept in its current state. As per the general rule, stock dividends are excluded from income if they are pro-rata distribution of stock. When dividend on the stock is not taxable, then the basis of such stock distributed is reallocated. If dividing shares are alike with previously held shares, then the basis for old stock is reapportioned by dividing taxpayer's cost in old stock with the total number of shares. When a dividend is not related with underlying shares, the basis is computed by apportioning basis of formerly held shares between old and new stock as per the fair market value of each. The holding period includes the holding period of the formerly held stock.

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