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Distributions of Stock and Stock Options

Many corporations may provide or distribute stock or stock rights to employees. When a corporation distributes it’s own stock, this would be referred to as a stock dividend and when a corporation grants stock rights, these are typically referred to as stock options. When individuals receive stock dividends and stock options, they generally will ask or inquire as to whether or not these dividends or stock options are taxable. Generally, the answer is no, stock dividends and stock options are not taxable, and thus not reported on an income tax return. However, under certain circumstances, the stock dividends or stock options can be taxable. These circumstances are discussed below, and please remember to always consult directly with your tax advisors regarding your specific circumstances.

A distribution of stock dividends and stock rights or stock options are taxable if any of the following apply:

1) The corporation distributes cash or other property to certain shareholders of the corporation and provides other shareholders with an increase in their percentage of interest in the assets and earnings and profits of the corporation.
2) The distribution can be converted by the shareholder into preferred shares.
3) Any shareholder has the ability to choose cash or other property be received as opposed to the stock or stock rights.
4) The distribution is a distribution of preferred stock. It should be noted, however, that such a distribution would not be taxable if it is solely an increase in a conversion ratio of convertible preferred stock, which has been made solely due to a stock dividend, stock splitting or similar action that would result in reducing the overall conversion rate.
5) The distribution allows for preferred stock to be issued to some common stock shareholders and common stock of the corporation to be issued to other shareholders.

When a taxpayer does receive a taxable stock dividend or stock rights, the taxpayer would include the fair market value at the time of the distribution in their income. It is also important for shareholders to be aware of constructive distributions. A shareholder may have to treat certain transactions that increase their proportionate share or interest in the earnings and profits or assets of the corporation as if stock or stock options were distributed if the result is the same as items 1, 2, 4 or 5 above. This treatment would apply to a change in a shareholder’s conversion ratio or redemption price, a difference between the stock’s redemption price and issue price, a redemption that is not treated as the sale or exchange of the applicable stock and other transactions whereby the similar effect is realized on the shareholder’s interest in the corporation. An example of a taxable distribution would be the receipt of preferred stock that holds a redemption price higher than the price the stock was issued for. This difference is considered the redemption premium, and generally the redemption premium would be considered a constructive distribution and taxable.

The above article has been prepared by John McGuire of the McGuire Law Firm for informational purposes and should not be considered tax or legal advice. John is a tax attorney and business attorney in Denver, Colorado and Golden, Colorado serving clients in Colorado and nationwide on certain tax matters.
Denver Tax Lawyer