Is Cash in Lieu Taxable? How It Impacts Your Taxes

Investors sometimes receive cash instead of shares they were expecting, often due to corporate actions like stock splits or mergers. This “cash in lieu” payment has tax consequences that many overlook. Understanding how these payments are classified and reported is essential for accurate tax filing.

Situations That Generate Cash in Lieu

Cash in lieu payments arise when investors are entitled to fractional shares due to corporate actions but receive cash instead. This typically happens in stock splits, mergers, or spin-offs where distributing whole shares isn’t feasible.

For example, in a 3-for-2 stock split, an investor with an odd number of shares may receive a fractional share. Since brokerages generally don’t issue fractional shares, they sell them and distribute the proceeds as cash.

Mergers and acquisitions also generate cash in lieu. If a company is acquired and shareholders receive stock in the new entity at a set exchange ratio, any fractional shares are usually converted to cash. For instance, if a merger grants 0.75 shares of the acquiring company for each share owned, shareholders with an odd number of shares will receive cash for the remaining fraction.

Spin-offs can have similar effects. When a company separates a division into a new publicly traded entity, existing shareholders receive shares in the new company based on a set ratio. If this results in fractional shares, brokerages typically sell them and distribute the cash proceeds.

Tax Classification of Cash in Lieu Payments

The IRS treats cash in lieu payments as proceeds from the sale of a capital asset rather than ordinary income. Since these payments result from selling fractional shares, they are subject to capital gains tax rules.

The tax treatment depends on how long the investor held the original shares. If the shares were held for more than a year, the gain is taxed at long-term capital gains rates, which range from 0% to 20% as of 2024. If held for a year or less, the proceeds are taxed at short-term capital gains rates, which align with ordinary income tax brackets, reaching up to 37% for high earners.

Brokerages report these transactions on Form 1099-B, categorizing them as stock sales. Investors must determine the cost basis of the fractional shares to calculate taxable gain or loss. The IRS requires allocating a portion of the original purchase price to the fractional shares. If the brokerage doesn’t provide the cost basis, investors must calculate it manually by prorating the original purchase price.

If the cash received is below a de minimis threshold, such as $20 or less, brokerages may not report it separately on tax forms. However, taxpayers are still required to include it in their calculations.

Reporting on 1099-B

Brokerages report cash in lieu payments on Form 1099-B, which summarizes capital transactions for the year. This form is sent to both the taxpayer and the IRS, ensuring that sales of securities, including fractional shares converted to cash, are recorded.

The form includes gross proceeds received, trade date, and whether the gain or loss is short-term or long-term. If the brokerage provides a cost basis, it simplifies tax calculations. If not, investors must determine it themselves, which can be challenging when shares were acquired at different prices. In such cases, taxpayers may need to refer to brokerage statements or use IRS-approved cost basis methods like FIFO (First-In, First-Out) or specific identification.

When filing taxes, amounts from Form 1099-B must be transferred to Form 8949, which itemizes capital transactions. The total is then reported on Schedule D of Form 1040, where overall capital gains and losses are calculated. If multiple 1099-B forms are received from different brokerages, each must be accounted for.

Adjusting Cost Basis

Determining the correct cost basis for cash in lieu transactions is necessary for calculating capital gains or losses. Since fractional shares are part of a larger investment, the cost basis must be allocated proportionally based on the original purchase price of the full shares.

For securities acquired in multiple transactions, cost basis calculations can be more complex. Investors must decide whether to use FIFO, which is the default method, or specific lot identification. This choice can significantly affect taxable gains, as older shares may have been purchased at a different price than newer ones.

Investors in dividend reinvestment plans (DRIPs) or dollar-cost averaging strategies must also account for fractional shares accumulated over time. These shares often have different purchase prices, requiring careful tracking to ensure gains are reported correctly. Brokerage statements may provide cost basis details, but investors should verify accuracy, especially if securities were transferred between accounts.

When It Is Considered a Dividend

While cash in lieu payments are generally treated as proceeds from the sale of a fractional share, there are cases where they may be classified as dividends. This happens when a company distributes cash instead of shares in a way that resembles a dividend rather than a stock sale.

One example is when a company issues a stock dividend but provides cash instead of fractional shares. If a shareholder is entitled to a portion of a share but receives cash instead, the IRS may classify it as a dividend. Qualified dividends, which meet IRS criteria such as being paid by a U.S. corporation and held for a minimum period, are taxed at 0%, 15%, or 20%, depending on income. Non-qualified dividends are taxed at ordinary income rates.

In certain mergers or reorganizations, cash payments may also be treated as dividends if they are considered part of a distribution rather than a sale. If a company issues a mix of stock and cash to shareholders and the cash portion isn’t directly tied to the sale of fractional shares, it may be classified as a taxable dividend. Dividend income is reported on Form 1099-DIV rather than 1099-B.