A stock split is an increase in the number of shares of a corporation’s stock without a change in the shareholders’ equity, and companies often split their shares to make them more affordable to investors (SEC, Investor.gov, Stock Split). The board declares a ratio, every holder’s share count rises in that proportion, and the per-share price falls in the same proportion, so the value of the position and the company’s market capitalization both stay where they were (FINRA, Stock Splits). Unlike issuing new shares, a split does not dilute the ownership interests of existing shareholders.
How the Ratio Works
Say you hold 10 shares of a stock trading at $100. In a 2-for-1 split the company gives you two shares with a market-adjusted worth of $50 for every one share you own, leaving you with 20 shares. In a 3-for-2 split it gives you three shares worth about $66.67 for every two existing $100 shares, leaving you with 15 shares. Either way the position is still worth $1,000, and the company’s market capitalization does not move (FINRA, Stock Splits).
A Reverse Split Runs the Same Arithmetic Backwards
A reverse stock split replaces several existing shares with one, and it tends to occur at small companies that believe their share price is too low to attract investors, or that need to hold a listing on a market with a minimum per-share price. In a 200:1 reverse split, an investor holding 5,000 shares at 10 cents, worth $500 in total, ends up with 25 shares at $20, still worth $500. The arithmetic is symmetrical, the signal is not. Reverse splits tend to go hand in hand with low-priced, high-risk stocks, and they are less common among seasoned companies on the major US exchanges (FINRA, Stock Splits).
What a Split Does to the Statements
Nothing in a split reaches the equity total, the residual that net assets measures, so the live question on the statements is timing.
A capital structure change to a stock dividend, stock split or reverse split that occurs after the date of the latest reported balance sheet but before the release of the financial statements must be given retroactive effect in the balance sheet, and an appropriately cross-referenced note should disclose the retroactive treatment, explain the change made, and state the date the change became effective (SEC, Codification of Staff Accounting Bulletins, Topic 4:C).
The Tax Treatment of Shares Already Held
A straight split of identical stock is not income. 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 (26 U.S.C. 305(a)).
What moves is basis per share. Stock dividends are generally not taxable and are not reported on the return, and the basis of a stock split is figured the same way as a stock dividend when identical stock is distributed on the stock held (IRS, Publication 550).
Where the new stock is identical to the old, divide the adjusted basis of the old stock by the number of shares of old and new stock, and the result is the basis of each share. The IRS works it on a single share bought for $45 that becomes three shares after two new shares are distributed for each share held, giving a basis of $15 per share (IRS, Publication 550).
old basis 45
shares after the split 1 + 2 = 3
basis per share 45 / 3 = 15
total basis 15 x 3 = 45The total never changes. Only the per-share figure does.
The clock does not restart either. The holding period for new stock received as a nontaxable stock dividend begins on the same day as the holding period of the old stock (IRS, Publication 550), so shares created by a split on a long-held lot are long-term the day they appear. Stock acquired from a decedent follows a different rule and takes a stepped-up basis instead.
One date governs the allocation, and it is not the record date. Basis is allocated in proportion to the fair market values of the old and new stock on the date of distribution, which the regulation defines as the date the stock is distributed to the stockholder rather than the date of record (Treasury Regulation 1.307-1).
Fractional Shares Are the Taxable Part
A ratio rarely divides evenly across every lot. The corporation may set up a plan under which fractional shares are not issued and are sold instead, with the cash proceeds given to shareholders, and cash received that way is treated as an amount realized on the sale of the fractional shares and reported on Form 8949 (IRS, Publication 550). That is an ordinary disposition of a capital asset, and its basis comes out of the same per-share allocation the split created.
The securities side expects that detail up front. An issuer’s notice of a stock split has to state the method of settlement of fractional interests (17 CFR 240.10b-17).
What the Issuer Has to File
Form 8937 is required when an organizational action affects the basis of a security’s holders, and the instructions name a nontaxable stock distribution including a stock split as an example. It is due on or before the 45th day following the organizational action or, if earlier, January 15 of the year following the calendar year of the action (IRS, Instructions for Form 8937).
Notice is not optional either. Failing to give notice of a stock split or reverse split is a manipulative or deceptive device under section 10(b) of the Securities Exchange Act, and notice counts only if given no later than 10 days prior to the record date (17 CFR 240.10b-17). The rule text still names the National Association of Securities Dealers as the recipient of that notice, and FINRA is the body that processes those corporate actions in the OTC market today (FINRA, Stock Splits).
Stock Split and Stock Dividend
For basis the method is the same when identical stock is distributed on the stock held. Nothing else about the pair matches.
Taxability is the first divergence. A stock dividend can be taxable, and Publication 550 lists five situations that make distributions of stock dividends and stock rights taxable, including a shareholder’s choice to take cash or other property instead of stock, a distribution that hands property to some shareholders and a larger proportionate interest to others, and a distribution on preferred stock (IRS, Publication 550).
The issuer’s own books are the second, and the line there is drawn by purpose rather than by ratio. Accounting Research Bulletin No. 43, Chapter 7B defines a stock split-up as an issuance of common shares without consideration, prompted mainly by a desire to increase the number of outstanding shares in order to reduce their unit market price. Where that is clearly the intent, no transfer from earned surplus to capital surplus or capital stock is called for beyond what legal requirements occasion (FASB, Accounting Research Bulletin No. 43, Chapter 7B).
The same bulletin defines a stock dividend as the same kind of issuance prompted mainly by a desire to give shareholders separate evidence of part of their interest in accumulated corporate earnings, and there an amount equal to the fair value of the additional shares issued moves out of earned surplus into permanent capitalization. Relative size is evidence of that purpose rather than the test itself, since no single percentage can be laid down as a standard, though few cases would arise where the market-price purpose is met by an issuance of less than, say, 20% or 25% of the previously outstanding shares (FASB, Accounting Research Bulletin No. 43, Chapter 7B).
The securities rules keep the pair apart as well. The SEC’s notice rule lists a dividend or other distribution as one reportable action and a stock split or reverse split as another (17 CFR 240.10b-17).
Common Questions
Neither, on its own. A stock split, or a reverse stock split, does nothing to change the value of a company, and how a stock performs over the long run depends on multiple factors rather than on how its shares are split (FINRA, Stock Splits).
From the issuer, not from a forecast. A company required to file reports with the SEC may notify shareholders of a reverse stock split in several ways, including on Forms 8-K, 10-Q or 10-K, all viewable through the SEC’s EDGAR search tools. An OTC company must submit notice to FINRA 10 days prior to the record or effective date of the corporate action, after which it posts to the OTC Daily List (FINRA, Stock Splits).
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