When you own stocks that pay dividends, you may choose to take the money in cash or you can reinvest dividend earnings to buy more shares. Many companies provide automatic dividend reinvestment plans, or DRIPs. Some firms also offer discounts and reduced transaction fees to encourage shareholders to participate in reinvestment plans. These features make it a little complicated to figure reinvesting stocks. However, it is useful information, especially since tracking your reinvested dividends can help you save money at tax time.
1. Determine the amount of your dividend payment. Dividends are usually paid quarterly, so multiply one-fourth of the annual dividend by the number of shares you own. For example, if you own 100 shares that pay a dividend of $4 per share each year, you would multiply $1 times 400 for a dividend payment of $400.
2. Add any discount you receive for reinvesting through a DRIP plan. Suppose your dividend payment equals $400 and you get a 10 percent discount. Add 10 percent for a total of $440. Keep a record of this amount. The IRS counts discounts as part of your dividend earnings, so in this example you would have to report $440 as ordinary income on your tax return for the year in which you receive the dividend payment.
3. Divide your total payment, including any discount, by the price per share. Suppose the stock is trading at $80 per share. If your dividend payment plus discount equals $440, your reinvestment purchases 5.5 shares.
4. Adjust for fractional shares. There is usually some money left over after buying whole shares that isn’t enough to buy an entire share. Companies usually credit this as a fractional share. Add the fractional share amount to any fractional share carried forward from the previous quarter. If you have enough to make a whole share, add it to the total number of shares you own. Thus, if you had a 0.7 fractional share from the previous quarter and add another 0.5 share, you end up with a whole share plus 0.2 shares to carry forward to the next quarter.
5. Calculate your cost basis or tax basis. Cost basis is the amount you subtract from the proceeds when you sell the shares to figure your taxable capital gain. The cost basis for a dividend reinvestment is the total value of the shares, including any discount, minus transaction fees you pay for the purchase of the shares. For instance, with a reinvestment of $440, if you are charged fees of $10, your cost basis equals $430. Keep a record of this amount along with your original stock purchase and other dividend payments. You will need this information to figure out your taxable gain when you eventually sell the shares.
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