Cash in Lieu of Shares: What It Means and How It Works

When companies undergo stock splits, mergers, or other corporate actions, investors may end up with fractional shares—portions of a full share that cannot be easily traded. Instead of issuing these fractions, companies or brokerages often compensate shareholders with cash payments, known as “cash in lieu of shares.”

Understanding this process is important for investors, as it affects portfolio value, tax obligations, and recordkeeping.

Events That Result in Fractional Shares

Corporate actions can leave investors with partial shares that are not tradable on major exchanges. One common scenario is a stock split, where a company increases the number of outstanding shares. If the split ratio does not result in a whole number of shares for an investor, a fractional share is created. For example, in a 3-for-2 stock split, an investor holding five shares would receive 7.5 shares post-split, leaving them with a 0.5 fractional share.

Mergers and acquisitions also frequently lead to fractional shares. When two companies combine, shareholders of the acquired company receive new shares based on a predetermined exchange ratio. If the ratio does not result in a whole number, the investor is left with a fraction. For instance, if a merger agreement states that each share of Company A will be converted into 0.75 shares of Company B, an investor holding 11 shares would receive 8.25 shares, leaving a 0.25 fractional share.

Reverse stock splits, where a company reduces the number of outstanding shares to increase the stock price, can also generate fractional shares. If a company executes a 1-for-3 reverse split, an investor with four shares would receive 1.33 shares post-split. Since exchanges do not support trading of fractional shares, the investor typically receives cash for the 0.33 portion.

How the Payment Amount Is Calculated

The cash payment investors receive for fractional shares is based on the stock’s market value at the time of the corporate action. The price used is typically the closing price on the effective date or the average trading price over a short period. Brokerages or transfer agents handling the transaction determine the exact pricing method, which is usually outlined in corporate filings.

Market fluctuations can influence the final amount paid. If a company’s stock is trading at $50 per share when the corporate action takes effect, an investor entitled to 0.25 of a share would receive $12.50. If the price drops to $48 by the time the brokerage processes the payment, the investor would receive $12.00. Some companies use volume-weighted average prices (VWAP) over several days to smooth out volatility.

Brokerages may deduct processing fees before distributing payments, though this varies by institution. Investors should check their brokerage’s policy to understand any potential deductions. Payment timing can also differ—some investors receive funds within days, while others may wait weeks, depending on how quickly the brokerage settles the transaction.

Accounting and Tax Treatment

Cash received in lieu of fractional shares is generally treated as a capital gain or loss for tax purposes, depending on the price originally paid for the stock. The IRS considers these payments as proceeds from the sale of a fractional share rather than a dividend or return of capital. Investors must calculate the gain or loss by comparing the cash received to the proportional cost basis of the fractional share. If the stock was held for more than a year before the corporate action, the gain or loss is taxed at long-term capital gains rates, which in 2024 range from 0% to 20%, depending on taxable income. Short-term holdings, those owned for one year or less, are taxed at ordinary income rates, which can be as high as 37%.

Determining the cost basis of a fractional share follows the same principles as full shares. If an investor acquired shares through multiple purchases, the IRS allows methods such as First-In-First-Out (FIFO), Last-In-First-Out (LIFO), or Specific Identification to track basis. Most brokerages default to FIFO unless the investor specifies otherwise. For example, if an investor bought 10 shares at $40 each and later purchased 10 more at $50, the cost basis of 0.5 fractional shares under FIFO would be $20 (0.5 x $40). If the investor receives $25 in cash, they would report a $5 capital gain.

Tax reporting requirements depend on the amount received. If total proceeds from cash in lieu transactions exceed $10, brokerages issue a Form 1099-B, detailing the sale and cost basis. Investors must report this on Schedule D and Form 8949 when filing taxes. If the amount is below $10, a 1099-B may not be issued, but the IRS still requires reporting. Failing to include these transactions can result in penalties or IRS notices, especially if the brokerage reports them.

Recordkeeping on Brokerage Statements

Maintaining accurate records of cash in lieu transactions is necessary for tracking investment performance and ensuring compliance with financial reporting requirements. Brokerage statements typically list these payments as “Cash in Lieu” or “CIL,” often categorizing them under corporate actions rather than standard dividend or interest income. Investors should verify that these entries align with transaction notices received from their broker to avoid discrepancies that could complicate tax filings or audits.

Most brokers automatically adjust an investor’s cost basis to reflect the removal of fractional shares, but errors can occur, particularly when shares are held in multiple accounts or transferred between firms. The IRS requires taxpayers to maintain supporting documentation for at least three years after filing a return, but retaining records indefinitely is advisable, especially for high-value portfolios where long-term capital gains calculations may span decades. Digital and paper copies of trade confirmations, corporate action notices, and tax forms can help substantiate reported figures if discrepancies arise.