Companies generally like to see the price of their stock rising, as it keeps the shareholders happy, and the shareholders are the ultimate owners of the company. But if the price gets too high, shares become harder to sell, limiting further price growth. That's why the board of directors may opt to split the stock -- put more shares into circulation at a lower price. Those new shares go to the existing stockholders.
When the board of directors decides to split a company's stock, its biggest decision is the split ratio -- how many additional shares each stockholder will get. The most common ratio is a 2-for-1 split, in which you receive one additional share for each share you already own. If you had one share before the split, you'd end up with two afterward. In a 3-for-2 split, meanwhile, you'd get one additional share for each two you already own. Though simple ratios are common, anything is theoretically possible: 7-for-1, 10-for-9 and so on.
A company planning a split will announce a date for the split -- the distribution date. On that date, your shares automatically multiply according to the ratio. If you hold your shares in a brokerage account, as most stockholders do, the company drops your additional shares in your account. Even if you own your shares outside a broker -- for example, because you bought them directly from the company's transfer agent -- your share ownership is still registered with the company. The company will credit you with the new shares and send you written confirmation that it has done so.
The share price falls after a stock split. (That's the purpose of the split, after all.) This reduction is automatic and takes place at the exchange where the company's stock gets traded. How much the price falls depends on the split ratio. A 2-for-1 split cuts the share price in half, for example, while a 3-for-1 cuts the price by two-thirds and a 3-for-2 cuts it by one-third. Investors don't actually lose any money, though. Each share is worth less money, but you've got more shares, so it evens out. For example, say a company decides to split its stock when the market price is $30 a share. In a 2-for-1 split, each $30 share becomes two shares worth $15 apiece. In a 3-for-2, you start out with two shares worth $30 apiece and end up with three shares worth $20 apiece.
Because the company distributes the new shares in direct proportion to the existing share ownership, a stock split doesn't increase anyone's stake in the company, either in dollar terms or in terms of percentage of ownership. You don't wind up with more value as a result of the split. For that reason, the new shares aren't subject to income tax.