What Happens in a Reverse Split if You Don’t Have Enough Shares?
Understand the implications for your holdings when a reverse stock split results in fractional shares, including company handling and tax considerations.
A reverse stock split consolidates a company’s shares, increasing the price per share. This action can result in shareholders owning fewer shares than the split ratio, leading to fractional shares. This article explores how these fractional shares are managed and their potential tax implications.
Fractional Shares in a Reverse Stock Split
A fractional share represents less than one full share of a company’s stock. In a reverse stock split, these emerge when an investor’s total share count does not align with the announced split ratio. Since stock exchanges typically only trade whole shares, these fractional amounts cannot be directly held or traded.
For example, if a company executes a 1-for-10 reverse split, an investor holding 7 shares would end up with 0.7 shares. An investor owning 23 shares in a 1-for-10 split would receive 2 whole shares and be left with a fractional 0.3 share.
The purpose of a reverse stock split is often to increase the stock’s trading price, potentially to meet minimum bid price requirements of an exchange or to attract a broader range of investors. While the overall value of a shareholder’s investment generally remains the same immediately after the split, fractional shares require resolution.
How Companies Handle Fractional Shares
Companies commonly address fractional shares by issuing a cash payout to shareholders. This is often the most frequent method, ensuring no fractional shares remain in circulation. The cash value is typically determined by multiplying the fractional share amount by the stock’s market price at the time the reverse split becomes effective. For instance, if an investor holds 0.7 shares from a split and the stock trades at $50 per share, they would receive $35.
Another method, though less common, is for the company to round the fractional share up to the nearest whole share. In this scenario, a shareholder might be granted an additional whole share, increasing their share count slightly. The specific method used is determined by the company’s board of directors and is communicated to shareholders in the reverse split announcement. Brokers typically handle these adjustments automatically, so individual shareholders do not need to take action.
Tax Considerations for Fractional Share Payouts
Receiving a cash payout for fractional shares generally has tax implications. This cash is typically treated as proceeds from the sale of a capital asset. Shareholders may realize a capital gain or a capital loss from this “sale,” depending on their original cost basis in the portion of shares sold. A capital gain occurs if the cash received exceeds the allocable cost of the fractional share, while a capital loss results if the cash is less than the allocable cost.
The gain or loss is considered short-term if the original shares were held for one year or less, and long-term if held for more than one year. Shareholders will need to adjust the cost basis of their remaining whole shares following the split. Companies and brokerage firms may issue IRS Form 1099-B to report these cash payments. Investors should keep records of their original share purchase price and the details of the reverse split for accurate tax reporting. Consulting a tax professional is recommended for personalized advice.