Surviving the Tax Season – The What, Why and How of Corporate Actions

With thousands of corporate actions occurring each year, the odds are good that an investor’s holdings will be affected by one of these events sooner or later. In many cases, a corporate action will result in a new position or a change to the cost basis of the security, and the IRS leaves it up the taxpayer to make all of the necessary adjustments.

Understanding what is involved when a corporate action takes place makes it easier to determine what (if any) adjustments need to be made by an investor or active trader when preparing their gains and losses for tax filing.

The following is a discussion of what the more common mandatory actions are, why companies choose to execute these events and how TradeLog users can effectively and accurately account for these actions on their trader tax forms.

What is a corporate action?

A corporate action is an event initiated by a public company that affects the securities issued by the company, generally agreed upon by the company’s board of directors and authorized by its shareholders. Some corporate actions may have a direct financial impact on the shareholders, for example, a dividend for an equity security or a coupon payment or call (early redemption) for a debt security. Certain corporate actions such as a stock split may have an indirect impact as the increased liquidity of the shares may cause the price of the stock to decrease. Other corporate actions such as name or CUSIP changes have no direct financial impact on the shareholders.

Types of Corporate Actions

A corporate action will fall into one of three categories: mandatory, voluntary, or mandatory with choice.

mandatory corporate action is an event initiated by a corporation’s board of directors that will affect all shareholders. The term “mandatory” is misleading, however, as the shareholder is just a passive beneficiary of the corporate action and no action needs to be taken by the holder.

voluntary corporate action is an action where the shareholders elect to participate in the action. A response is required for the corporation to process the action. An example of a voluntary corporate action is a tender offer. A corporation may request share holders to tender their shares at a pre-determined price. Shareholders send their responses to the corporation’s agents, and the corporation will send the proceeds of the action to the shareholders who elect to participate. Other types of voluntary actions include rights issue, making buyback offers to the shareholders while delisting the company from the stock exchange etc.

mandatory with choice corporate action is a mandatory corporate action where shareholders are given the opportunity to choose among several options, such as a cash or a stock dividend with one of the options set as a default. In the event a shareholder does not submit the election, the default option will be applied.

Does TradeLog automatically adjust for all mandatory corporate actions?

TradeLog software was primarily developed to help taxpayers account for corporate actions that affect cost basis or capital gains tax for the IRS Schedule D.

While our goal is to create a software program that is as user-friendly as possible and we make every effort to automate adjustments to your trade history in TradeLog for corporate actions, this is not always feasible because:

  1. Brokers often will not report these events in the trade history which is imported into TradeLog. A brief mention of the corporate action may be found on a client’s monthly statement but it is often left up to the client to research the particulars of the event (ex. the effective date, the stock split ratio, etc).
  2. Certain types of corporate actions require the taxpayer to make decisions about adjustments to their trades that have tax implications and may require consulting with a CPA or tax advisor.
  3. In recent years, companies have been favoring more complex corporate restructuring events involving mergers with name and/or ticker changes, stock splits and cash payouts. Here are just two examples of this we saw during the 2016 tax year:

HERTZ (HTZ) – name change, spin-off of HRI stock and multiple stock splits for HTZ and HRI

In June of 2016, Hertz announced the separation of its car rental and equipment rental businesses. HTZ underwent a name change to Hertz Global Holdings but maintained the same ticker symbol. Spin-off shares of a new entity named Herc Holdings (HRI) were issued. The Hertz Global Holdings shares underwent a 1-for-5 stock split. The new Herc Holdings shares underwent a 1-for-15 split.

Lionsgate (LGFB) and Starz (STRZA) – ticker change and stock split for LGFB stock, cash payouts and stock splits for STRZA stockholders

In December of 2016, Lionsgate finalized the merger/acquisition of Starz. Each share of existing LGFB stock was converted into 0.5 new voting shares of Lionsgate (LGF.A or LGF.B). Existing Starz shareholders were issued a cash payout plus new shares of Lionsgate non-voting stock (Series A holders were paid $18.00 per share and given 0.6784 shares of Lionsgate LGF.B stock and Series B holders were paid $7.26 per share and given 0.6321 shares of Lionsgate LGF.B stock).

Sounds complicated, right? Now factor in that the results of these complex corporate events may only show up on your broker’s monthly statement as a simple adjustment to your previous holdings. Or the trade history reporting includes “opening” (buy) or “closing” (sell) transactions for a new ticker symbol that is not currently in your TradeLog file so the software cannot match the trades together properly after you import. We can see how making adjustments for these corporate actions can be tricky and as mentioned, we make every effort to automate these adjustments but some user intervention may be needed.

TradeLog Quick Tips

Importing your trades from your online broker on a monthly basis and adjusting for corporate actions as they occur throughout the tax year makes reconciling your trades much easier come tax time!

Common Corporate Actions and Possible Adjustments

In this section, we will discuss some of the more common mandatory actions that TradeLog software users may come across in their broker’s trade history reporting or monthly statements.

Example# 1: Company name or CUSIP changes.

Often due to a merger, acquisition, restructuring plan or new corporate branding strategy, a company’s publicly listed name and/or the CUSIP symbol for their stock may change. TradeLog matches your trades based on the value in the “Description” column so if your broker did not make the ticker/CUSIP adjustment in their trade history reporting, you may need to manually edit the ticker symbols in certain transactions so your trades will match correctly. This is a very simple function – see Changing Tickers for more details. Your broker may report a brief note about the corporate action on your monthly statement.

Example# 2: Cash dividends.

Many investors like the steady income associated with dividends, so they will be more likely to buy that company’s stock. Investors also see a dividend payment as a sign of a company’s strength and a sign that management has positive expectations for future earnings.

All stockholders are entitled to receive the dividend payments, normally out of the corporation’s current earnings or accumulated profits. All dividends must be declared by the corporation’s board of directors, and they are taxable as income to the recipients. In most cases, your broker will send you – and the IRS – a combined 1099 statement which reports your dividend payments and other income distributions from stocks or mutual funds in a section labeled “1099-DIV”, but will not necessarily indicate if your dividends are qualified or not. It is up to you to examine carefully the many factors determining which of your dividends qualify as “capital gains” and should therefore receive the lower tax rate. Dividends are still considered ordinary income and cannot be offset against net capital losses. They are reported on your Form 1040, not on the Schedule D along with stock and option capital gains and losses, and so are not imported into or recorded in your TradeLog software.

Example# 3: Stock splits.

If the price of a company’s stock is too high or too low, the liquidity of the stock suffers. Stocks priced too high will not be affordable to all investors and stocks priced too low run the risk of being de-listed. Corporate actions such as stock splits or reverse stock splits increase or decrease the number of outstanding shares, resulting in a higher or lower stock price.

When a corporation decides to execute a forward stock split, the number of outstanding shares will increase while the overall market value of the position will remain the same. The number of shares you own in the company will increase but the value of each individual share will decrease.

Example: if you own 10 shares of XYZ valued at $10 each, and XYZ executes a 10 for 1 (10:1) stock split, you will now own 100 shares valued at $1 each.

When a corporation executes a reverse stock split, the number of outstanding shares will decrease while the market value for each of those individual shares will increase.

Example: if you own 10 shares of XYZ valued at $10 each, and XYZ executes a 1 for 10 (1:10) reverse stock split, you will now own 1 share worth $100.

Regardless of the type of split executed, your equity in the stock will remain the same and no monetary gain or loss results from the stock split. However, your broker will generally adjust the number of shares held in your account (and report this on your monthly statement) but will not adjust the price (“cost basis”) of the original shares you purchased in their trade history reporting, monthly statements or tax reporting.

TradeLog has a simple Adjust for Stock Split function to help you account for this corporate action accurately – simply enter the ticker symbol of the security affected by the stock split, enter the ratio (ex. “2” for “1”, or “1” for “2” in the case of a reverse split) and the software does the rest. This function will change the number of shares owned as well as the price of these shares, effectively changing the cost basis of each share while the total amount paid for all of your open shares remains the same. You may find Example of Stock Split Adjustment to be a helpful reference.

Example# 4: Mergers.

Corporations re-structure in order to increase their profitability. Mergers are an example of a corporate action where two companies that are competitive or complementary unite into one newly named company. This is often done to expand a company’s reach, expand into new segments, gain market share and increase profitability. The buying or “parent” corporation may choose to execute a cash merger/liquidation or a stock merger.

In a cash merger/liquidation example, Company A purchases Company B and declares Company B shareholders will receive $10.00 for every 1 share they owned. The common stock of Company B stops trading and its shareholders are given a cash payout instead. As TradeLog handles trade reconciliation and does not track cash transactions, you can handle the payout in one of two ways:

  1. You can adjust the cost basis of the opening transaction (buy) to include the cash you received. This may be the clearest method since the payout would typically be reported on your broker’s 1099-B. Please see Adjusting Cost Basis Amount in our online user guide for details. You would manually enter a closing transaction (sell) as of the buyout shown on your monthly statements, at a zero price per share, allowing you to claim the capital gain or loss. Please see Manually Entering a Trade in our online user guide. The same tax rules apply to a stock buyout as to your own buying and selling activity – if you have held the shares less than one year, you will owe short-term capital gains tax on the profits; if the holding period was more than one year, long-term gains rates apply.
  2. You can attach a simple statement to your tax return stating that TradeLog does not handle cash transactions and note the transactions causing the difference in cost basis or gross proceeds. Or you can ask your accountant to create a footnote to your return explaining the difference. The IRS states that the “burden of proof is on the taxpayer” so either format would be acceptable for filing.

In a stock merger example, Company A purchases Company B and declares that Company B shareholders will receive 2 shares of Company A for every 1 share of Company B they owned. The common stock of Company B stops trading and Company B shareholders now own Company A shares instead. Your total cost basis for these new shares does not change, only the ticker and quantity of those shares will change. Please see Adjusting for Mergers in our online user guide for step-by-step instructions for editing trades affected by a stock merger. Brokers generally do not make these adjustments in their trade history reporting but may include helpful notes regarding a merger on a client’s monthly statement.

Occasionally, a company that undergoes a merger also executes a stock split. These don’t typically occur on a one-for-one basis. As in a stock split, the amount of the new company’s shares received in exchange for your stake in Company A is represented by a ratio; for example “1-for- 2.25” where one share of the new company will cost you 2.25 shares of Company A. This type of corporate action will often result in extra “fractional” shares (less than one full share) being left over.

Example: you own 10 shares of the new XYZ Corporation. XYZ undergoes a 1:3 reverse stock split as a result of the stock merger. You will technically now own 3.33 post-split shares of XYZ. If you execute a closing transaction (sell) for 3 shares of XYZ in your broker account, you are left with a balance of 0.33 shares.

If these fractional shares are causing trade matching issues such as “negative share errors” (more shares closed than were previously opened) or false “open positions” as shown above, a TradeLog user will need to adjust the cost basis of the opening transaction (buy) for the whole shares and then delete the remaining fractional shares. Please see Manually Editing Fractional Shares for more details.

Alternatively, the corporation may decide to pay the stockholders “cash in lieu” of fractional shares resulting from a corporate action. TradeLog does not handle cash transactions but you can either adjust the cost basis of the opening transaction (buy) to include the cash you received or attach a simple statement to your tax return stating that TradeLog does not handle cash transactions and note the transactions causing the difference in cost basis or gross proceeds.

Example# 5: Spin-offs.

A parent company may create an independent company through the sale or distribution of new shares of an existing business or division of the company. This is often done to streamline operations or sell off less productive subsidiary businesses. For example, a company might spin off one of its businesses experiencing little or no growth so it can focus on a product or service with better potential. The spun-off companies are expected to be worth more as independent entities than as parts of a larger business.

A corporation creates a spin-off by distributing 100% of its ownership interest in that business unit as a stock dividend to existing shareholders. It can also offer its existing shareholders a discount to exchange their shares in the parent company for shares of the spin-off. For example, an investor could exchange $100 of the parent company’s stock for $110 of the spin-off’s stock. Spin-offs tend to increase returns for shareholders because the newly independent companies can better focus on their specific products or services. Both the parent and the spin-off tend to perform better as a result of the spinoff transaction, with the spin-off being the greater performer. As no money changes hands, the spin-off distribution is generally a non-taxable event.

As brokers vary widely as to how they report spin-offs on their statements, TradeLog does not automate the importing of these spin-off transactions but allows the user to determine how best to account for the new stock. You may need to enter a new transaction in TradeLog for the stock you received – see Adjusting for Spinoffs and Corporate Actions – Stock Spinoffs for step-by-step instructions and examples.

Example# 6: Return of capital.

This refers to principal payments made back to “capital owners” (shareholders, partners or unit-holders) that exceed the current and accumulated earnings and profits of a business or investment. This corporate action will generally not affect the number of shares you hold. Brokers will report the amount of the return of capital distribution on Form 1099-DIV.

Return of capital can occur for a variety of reasons. For example, a mutual fund may decide to distribute more than it has earned, in order to maintain a constant distribution even when income falls. In the case of a Real Estate Investment Trust (REIT), income for tax purposes is often less than net cash flow due to capital cost allowance for depreciation on its properties. As a result, if the REIT distributes its entire net cash flow to unit holders, the distribution will exceed net income and a portion of it will be considered return of capital.

The return of capital distribution is a return of the shareholder’s original investment and is non-taxable. However, the cost basis of the security must be reduced by the amount of the return of capital. As a result, the capital gain is greater when the investment is eventually sold. See Adjusting Cost Basis Amount in our online user guide for instructions regarding how to edit your cost basis for these trades.

Example# 7: Bonus Issue

Companies may decide to issue free “bonus” shares to their shareholders as an alternative to cash dividends when they are facing cash flow difficulties or need to restructure company reserves and are not in a position to distribute a dividend in cash to shareholders who expect a regular income from their investment. Shareholders can then sell the bonus shares to meet their liquidity requirements. The downside to a bonus issue is that the day after the bonus is distributed, the share price is adjusted. For example, if the company has issued a 1:1 bonus share, the price of the shares will fall to nearly half is original price, a reflection of the company’s value in the market. Bonus shares are also known as “scrip issue”, “scrip dividends” or “capitalization issue”.

Bonus shares are issued to each shareholder based on the number of shares they currently own prior to the effective date of the bonus issue. Similar to a stock split, a 1-for-5 bonus issue, for example, would entitle each shareholder 1 new share for every 5 shares held but the new shares would be distributed to the shareholder free of charge. TradeLog users may need to enter a new “opening” (buy) transaction for the new shares at zero price if the bonus shares were not reported in the trade history – see Manually Entering a Trade in our online user guide.

Example# 8: Stock buybacks.

A buyback is a corporate action where a company repurchases its own stock by distributing cash to existing shareholders in exchange for a fraction of the company’s outstanding equity; cash is exchanged for a reduction in the number of shares on the open market. Although stock price appreciation and dividends are the most common methods used by companies to return wealth to their shareholders, a buyback increases the relative ownership stake of each investor increases as there are fewer shares, or claims, on the earnings of the company.

The most common form of buyback used by corporations is a voluntary corporate action called a “tender offer”. Shareholders are presented with a tender offer by the company to submit a portion or all of their shares within a specified time frame. The number of shares the company is seeking to repurchase and price range they are willing to pay are outlined in the offer. To induce the shareholders to sell, the offer price is usually at a premium over the current market price of the company’s shares. For example, if a corporation’s stock were trading at $20 per share, the corporation might offer $21.50 per share to shareholders on the condition that 51% of shareholders agree. Shareholders submit the number of shares they want to tender and the price they are willing to accept. The company will review these and select offers that allow them to buy the desired shares at the lowest cost.

Example# 9: Rights and Warrant Offerings

rights offering, also known as a rights issue, is a voluntary corporate action executed by a company that allows its shareholders to purchase additional stock shares at a discounted trading price. Companies generally issue rights in an effort to raise additional capital to meet current financial obligations or to fund expenditures for expansion of the company’s business.

Example: a shareholder owns 100 shares in XYZ, each worth $6 at the current market price. XYZ extends a rights offering to raise $40 million to cover outstanding debt, with 10 million stock shares made available at $4 per share with a “4-for-10” rights issue. For every 10 shares of stock a shareholder owns, he can purchase four shares at the discounted price of $4 per share.

Shareholders can respond to the rights offering in one of three ways:

  1. Accept the rights offering and purchase as many shares as desired up to the maximum outlined in the terms of the offering,
  2. Ignore the rights offering and let the rights expire without purchasing any additional shares, or
  3. Transfer or sell their rights to another investor or underwriter (if transferable).

If you choose to participate and exercise your rights, your broker will generally report the purchase of the new shares in your trade history or on your monthly statement. If this opening transaction is missing from the trade history, you will need to enter it manually with the date you elected to exercise, the total number of shares you purchased, the price paid per share and any fees or cash paid to exercise. Please see Manually Entering a Trade in our online user guide.

Similar to a rights issue, a warrant offering is a voluntary corporate action that gives the shareholders the right to purchase shares of a company’s stock at a certain price within a fixed period of time (typically up to 5 years, some are perpetual). A company will often issue a bond and attach a warrant to the bond to make it more attractive to investors. Warrants are attractive to the issuer as they afford it the ability to issue either preferred stock or bonds at a lower interest rate that it would otherwise have to for a similar security. Their value to the stockholder is the ability to participate in the potential appreciation of the issuer’s equity securities at a considerably lower cost and maintain the downside protection of the bond.

If the issuer’s stock increases in price above the warrant’s stated price, the investor can redeem the warrant and buy the shares at the lower price. For example, if the warrant has a strike price of $10 per share and the market price of the stock rises to $15 per share, the investor can redeem the warrant and buy the shares for $10 per share. If the stock never rises above the strike price, the warrants expire worthless. Again, if you choose to participate and exercise your warrants, your broker will generally report the redemption and purchase of the new shares in your trade history or on your monthly statement. If this opening transaction for the new shares is missing from your broker’s trade history reporting, you will need to enter it manually with the date you elected to exercise, the total number of shares you purchased, the price paid per share and any fees or cash paid to exercise. Please see Manually Entering a Trade in our online user guide for assistance with adding trades.

Rights and warrants are recorded in TradeLog with the same multiplier as stock (STK-1) as they are taxed in the same manner as any other security. The difference between the exercise and sale prices of these securities is taxed as a long- or short-term gain. Any gain or loss realized from trading rights or warrants in the secondary market is taxed in the same manner (except that all gains and losses will be short-term).

By understanding these different types of corporate actions and their effects, an investor can have a clearer picture of what these events indicate about a company’s financial affairs and how that action will influence the company’s share price and performance. This will aid the investor in determining whether to buy or sell a security.

Unlike other popular tax software programs, TradeLog was designed specifically to meet the tax filing needs of investors and active traders, closely adhering to IRS guidelines for taxpayers. The software makes the process of adjusting your trades for these corporate actions and determining your gains and losses for filing much easier and less stressful.

Notice what some of your fellow traders are saying about TradeLog:

“TradeLog has developed a fantastic program for individual traders that has taken the headache out of year-end tax reporting. But the best thing is the customer service… Thank you, TradeLog…you have made my life so much easier.”

“I was pretty hesitant to drop the $ on your software for 1 year, but I gave it a shot, and I was really impressed. It took what would have been a multi-day, error-prone job and simplified it to a few minutes of work…TradeLog is easily worth the money. I can now feel confident filing my taxes that wash sales are correctly calculated. Thanks again for a great product.”

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Please note: This information is provided only as a general guide and is not to be taken as official IRS instructions. Cogenta Computing, Inc. does not make investment recommendations nor provide financial, tax or legal advice. You are solely responsible for your investment and tax reporting decisions. Please consult your tax advisor or accountant to discuss your specific situation.