Don't just pay tax on the whole cash in lieu payment. You have cost basis in the
fractional share that you are entitled to use.
STOCK SPLITS:
Here is an example of how to record a stock split.
Assume that you bought 100 shares of IBM on 4/2/2000 for $2000.00
On 5/2/2001, IBM declared a four for one stock split and you received 300
additional shares.
Your original cost basis for 100 shares was $20.00 per share, total cost $2,000.00
Your adjusted cost basis for 400 shares is now $5.00 per share, total cost $2,000.00
You still own the same percentage ownership of the business and no true economic
value has been added to your investment by the stock split. However, because the
trading price of the stock will also be reduced to about 1/4 of its original market
price, there is often a positive psychological effect on investor confidence and
marketability. The reason for this is because it brings the stock price range down
to a lower price so that investors can more easily afford to buy it in round lots of
100 shares. It also signals that management is confident that they can maintain the
price at a trading floor in that range.
REVERSE SPLITS:
Reverse splits usually occur when management is trying to get a very low-priced
stock to trade at a higher price range.
Here is an example of how to record a reverse stock split:
Assume that you bought 1,000 shares of XYZ Corp on 4/2/2000 at $20.00 per
share for a total cost of $20,000.00.
By 5/2/2001, the market price for the stock had fallen to $2.00 per share, a
market loss of 90%.
On 5/2/2001, XYZ declared a reverse one for ten stock split.
Your brokerage firm delivered off 1,000 shares of the "old" XYZ shares and
received 100 shares of the "new" XYZ Corp stock in exchange.
After the exchange, the "new" shares began trading in the stock market for
about $20.00 per share.
Your original cost basis for 1,000 "old" shares was $20.00 per share, total cost $20,000.00.
Your adjusted cost basis for 100 "new" shares is now $200.00 per share, with the
same total cost $20,000.00
You still own the same percentage ownership of the business and no true economic
value has been added to your investment by the reverse stock split. However,
because the trading price of the stock will also be increased to about ten times its
prior market price trading range, there is often a positive psychological effect on
investor confidence and marketability. The reason for this is because it brings the
stock price range up to a higher, more normal price that investors are used to
seeing. Investors often shy away from stocks trading below $5.00 due to perceived
higher risk.
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