In Part III, we'll complete our discussion by briefly talking about the tax issues when a company spins off into multiple companies, or when Company A purchases Company B using cash, stock, or a combination of the two. How in the world do you allocate the cost basis in your original shares when something like that happens?
Easy, follow the instructions. "What instructions?" you might ask. Is there a specific allocation formula in some IRS publication that will tell you how to make these computations? Or, is there some other "standard" computation that you must perform?
The answer is a resounding no. But, we're not trying to torture you -- there are instructions. You'll get them from the companies involved in the spin-off, split-up, or purchase. And, that is the only place you'll find those instructions, so watch for them.
When these transactions take place, the legal and accounting folks get together and create a formula that you must follow to allocate your basis in the old and new shares. Many times, these computations are fairly easy to follow. In other cases, the computations can be quite complex. Regardless of the ease or complexity of the transaction, the only way you can correctly allocate your stock basis is to follow the formula issued by the company.
How do you receive this formula? Many times, your broker will forward the notice to you -- just like quarterly or annual reports or voting proxies for the stocks you hold in your portfolio. You might open it, look at it, and then throw it away because it seems like a lot of legal jargon. You already know about the spin-off or split-up, and you don't really want to read any more about it. But, if you wade through the paperwork, you'll find the formula.
You might also think that this formula is not very important to you, since you are not interested in selling the stock yet. But, now is the best time to deal with these issues not years down the road. Why deal with it now? Because figuring out your new cost basis is really the only way to track the performance of your new shares and determine your potential gain or loss should you decide to sell the shares later.
Also, it'll be one less thing you have to deal with at tax time when you finally do decide to sell the shares and must allocate your basis for tax gain or loss purposes. The last thing you want when you are fighting the April 15th deadline is to have to find the appropriate formula, apply it to your basis, and determine your taxable gain or loss. In some cases, what you thought was a large gain may only be a marginal gain. This could really screw up your tax planning. So, the very best time to obtain the formula and allocate your basis is as soon as possible after the stock transaction takes place.
In many cases, this formula will produce "fractional shares" that the company will purchase from you. Please understand that this is a real, live stock sale, and a sale that must be reported on Schedule D in the year that the fractional shares are sold. Again, the only way to compute your basis on those fractional shares and your taxable gain or loss on those fractional shares is to correctly allocate your cost basis using the formula provided by the company.
This is another reason to allocate your basis in your old shares soon after you are notified about the stock transaction. Many people believe they can ignore their basis allocation computations and simply report the fractional-share sale as a dividend on Schedule B. Or, in other cases, some taxpayers simply report the sale of the fractional shares on Schedule D, but with no basis allocated to the shares. In either case, you'll be paying more taxes on this sale than you should. And, if you ignore the basis computations when dealing with these fractional shares, it will only make your future basis computations that much more difficult to deal with.
So, what do you do if you find April 15th looming and have not yet computed your cost basis on a spin-off or split-up transaction that may have taken place a few months (or years) ago? First, you get the formula from the companyor from another resource. The Motley Fool Stock discussion boards are a great place to discuss these computations, and sometimes even to obtain the formula.
If that doesn't work for you, try the company's website, probably in a section devoted to financial information or investor relations. In most cases, you'll find the formula information there.
Still no good? Call your broker, who should be able to provide you with the formula. If all else fails, call the company directly and ask to speak to someone in the Investor Relations department. They'll certainly have a copy of the formula and will mail the information to you. If speed is of the essence, they may even be willing to email or fax the information to you. Don't be afraid to ask.
What you can't do is find the exact formula in some IRS Publication, tax form, or tax guide. It just won't exist there. There is only one specific, unique formula that applies to your stock transactions, and it's determined and supplied by the company. Get it. Grab your calculator, a pencil, a few sheets of paper, and perhaps a cup of coffee. Then do your computations and get your new tax basis. Do it now. You'll be glad you did.