Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 76-53

1976-1 C.B. 87

Section 301
Section 305
Section 1001
Section 1002

IRS Headnote

Stock dividends; dividends reinvested in stock at discount. The distribution of stock pursuant to a plan whereby the common shareholders may exercise the option of having their cash dividends automatically applied to the purchase of additional stock at a discount constitutes a distribution of property to which section 301 of the Code applies by reason of section 305(b)(1) and the value of the stock distributed equals its fair market value on the date of distribution.

Full Text

Rev. Rul. 76-53

Advice has been requested concerning the Federal income tax consequences of the transaction described below.

X, a widely held corporation that regularly distributes its earnings and profits, adopted a plan permitting the shareholders of X to choose to have all of the cash dividends otherwise payable on the common shares owned by the shareholder automatically invested to purchase additional shares of X common stock. The shareholders who elect to participate in the plan acquire X stock at a price equal to 95 percent of the fair market value of such stock on the dividend payment date. The shareholders' option to purchase common stock under the plan is not transferable apart from a transfer of the common shares themselves.

In addition, shareholders participating in the plan, as well as other common shareholders, can make optional cash payments up to a specified amount for the purchase of additional X common stock. The shares so acquired with optional cash payments are purchased at 100 percent of fair market value of the X stock on the dividend payment date.

There is no requirement to participate in the plan and shareholders who do not participate receive their cash dividend payments in full. While the plan continues in effect, a participant's dividends will continue to be invested without further notice to X.

Prior to the dividend payment date no cash dividend is available to either X's participating or nonparticipating shareholders. The dividend payment date is the date the participant's option to receive stock becomes effective and a participant receives written notification that X is acting to effectuate the participant's option to receive stock on that date. The crediting on the plan account and notification to the participant of the exact number of shares acquired (including fractional shares) takes place shortly after the dividend payment date.

A participant may withdraw from the plan at any time, and certificates for whole shares credited to the participant's account are issued to the participant. Fractional share interests are sold by an independent fiduciary institution acting on behalf of the participant. The proceeds of the sale (less any brokerage commission and transfer tax) are forwarded to the participant. X does not purchase such fractional share interests and does not pay any expenses in connection with the sale attributable to the participants. If the number of shares credited to the participant's account is less than 25, the participant may request that all of the shares (including fractions) be sold. The sale will be made by an independent fiduciary institution acting on behalf of such participant and the proceeds of the sale (less any brokerage commission and transfer tax) are forwarded to the participant. In these circumstances, X will neither purchase any shares of a participant nor pay any expense attributable to the participant. A participant can request that a particular dividend not be applied to the acquisition of additional shares under the plan, and in such case receive the cash dividend otherwise payable. This action does not constitute a withdrawal from the plan, and shares already credited to the participant will remain in his account.

Section 305(a) of the Internal Revenue Code of 1954 provides that, with certain exceptions, gross income does not include the amount of any distribution of the stock of a corporation made by such corporation to its shareholders with respect to its stock. Section 305(d)(1) provides that for purposes of the foregoing the term "stock" includes rights to acquire such stock.

Section 305(b)(1) of the Code provides that section 305(a) will not apply, and the distribution will be treated as a distribution to which section 301 applies, if the distribution is, at the election of any shareholder (whether exercised before or after the declaration), payable either in the stock of the distributing corporation or in property.

Section 1.305-2(a) of the Income Tax Regulations provides that if any shareholder has the right to an election or option with respect to whether a distribution shall be made either in money or any other property, or in stock or rights to acquire stock of the distributing corporation, then, with respect to all shareholders, the distribution of stock or rights to acquire stock is treated as a distribution of property to which section 301 of the Code applies regardless of (1) whether the distribution is actually made in whole or in part in stock or in stock rights; (2) whether the election or option is exercised or exercisable before or after the declaration of the distribution; (3) whether the declaration of the distribution provides that the distribution will be made in one medium unless the shareholder specifically requests payment in another; (4) whether the election governing the nature of the distribution is provided in the declaration of the distribution or in the corporate charter or arises from the circumstances of the distribution; or (5) whether all or part of the shareholders have the election.

Section 1.305-1(b)(1) of the regulations provides that where a distribution of stock or rights to acquire stock of a corporation is treated as a distribution of property to which section 301 of the Code applies by reason of section 305(b), the amount of the distribution, in accordance with section 301(b) and section 1.301-1 is the fair market value of such stock or rights on the date of the distribution.

Section 1.305-1(b)(2) of the regulations provides that where a corporation that regularly distributes its earnings and profits, such as a regulated investment company, declares a dividend pursuant to which the shareholders may elect to receive either money or stock of the distributing corporation of equivalent value, the amount of the distribution of the stock received by any shareholder electing to receive stock will be considered to equal the amount of the money that could have been received instead.

Applying these rules to the facts of the instant case, the distributions made by X while the plan is in effect are properly treated as payable either in X's stock or in cash at the election of X's common shareholders within the meaning of section 305(b)(1) of the Code and the regulations thereunder. See Lester Lumber Co., 14 T.C. 255 (1950). Furthermore, the special rule of section 1.305-1(b)(2) of the regulations that provides that the amount of the distribution of the stock received by any shareholder electing to receive stock of the distributing corporation of equivalent value is considered to equal the amount of money that could have been received instead, is not deemed applicable to the distributions made by X while the plan is effective because the common stock acquired by the participants under the plan at a discount of five percent has a greater fair market value than the cash dividend that could have been received in lieu thereof.

Accordingly, under the circumstances described above, it is held as follows:

1. A shareholder of X who participates in the plan will be treated as having received a distribution to which section 301 of the Code applies by reason of the application of section 305(b)(1). Pursuant to section 1.305-1(b) of the regulations, the amount of the distribution to the participating shareholders (including participating corporate shareholders) will be the fair market value of the X stock received on the date of the distribution. Sections 1.301-1(b) and (d). The amount of the distribution to the nonparticipating shareholders under section 301 will be the amount of the cash received by such shareholders. Section 1.305-2(b), Example (1).

2. The basis of the shares credited to the account of a participating shareholder pursuant to the dividend reinvestment aspect of the plan will equal the amount of the distribution measured by the fair market value of the stock as of the date of the distribution both as to non-corporate and corporate participating shareholders. Section 1.301-1(h)(1) and (2)(i) of the regulations. The basis to the shareholders participating in the optional payment aspect of the plan, is the cost paid by such shareholders in acquiring the stock. Section 1012 of the Code.

3. The holding period for shares credited to a participant's plan account pursuant to the dividend reinvestment aspect of the plan will begin on the day following the date of the distribution. The holding period for shares purchased by optional cash payments will begin on the day following the date of purchase. See  Rev. Rul. 70-598, 1970-2 C.B. 168.

4. A participant in the plan will not realize any taxable income upon the receipt of certificates for whole shares that were credited to the participant's account, either upon the participant's request for certificates for certain of those shares or upon withdrawal from or termination of the plan. However, a participant will recognize gain or loss under section 1002 of the Code when shares are sold or exchanged on behalf of the participant pursuant to the participant's request to withdraw from the plan and the number of shares credited to the participant's account is less than 25, or by the participant after withdrawal. In the case of a fractional share, gain or loss will be recognized under section 1002 of the Code when the participant receives the proceeds of the fractional shares sold for the participant's benefit upon withdrawal from or termination of the plan. In accordance with section 1001, the amount of such gain or loss will be the difference between the amount that the participant receives for the full and/or fractional shares pursuant to the plan and the participant's tax basis therefor.