Corporate Actions

Definition of a Corporate Action

A corporate action is any material change to a security, including name changes, stock splits, spin offs, and mergers, to name just a few. In many cases, a corporate action will result in a new position or a change to the cost basis of the security. Not surprisingly, it is up to the investor to make all the necessary cost basis adjustments for each security. With over 6,000 corporate actions annually that affect a stock's cost basis, the odds are good that an investor will encounter one sooner or later. Some corporate actions are manageable; however other corporate actions require more laborious calculations. Each corporate action type has its own rules that investors must learn if they are to accurately complete their Schedule D forms.

The arduous task of tracking and adjusting for corporate actions can be further complicated by wash sale activity. GainsKeeper’s wash sale algorithms are synchronized with corporate action activity to alleviate this problem.

Some Types of Corporate Actions

Merger: A merger is a corporate action that results when two companies join together to form one company. Mergers can be taxable or non-taxable. If a merger is taxable an investor will need to realize an "artificial" sale and re-purchase the security. For a non-taxable merger an investor will need to allocate the cost basis to the new security.

Spin Off: A spin off is a corporate action that occurs when a company distributes part of its assets to form a new publicly traded company. When a spin off occurs stockholders of the parent company receive shares of the new company in the form of a stock dividend.

Stock Split: A stock split is a corporate action that occurs when a company changes the amount of shares it has outstanding and then adjusts each share's price accordingly. The number of shares received as a result of a stock split is a ratio of the total shares owned right after the split. Stock splits are usually non-taxable. It is important to note that after a stock split the number of shares owned in the security and the cost basis of those shares will change. Often stock splits are expressed as a fraction. A two for one stock split, where the investor receives one additional share for every share owned in the security, is the most common type of stock split.

Qualified Dividend

Qualified dividends are dividends that are taxed at the lower 5 or 15 percent tax rates instead of at the ordinary income tax rate. The IRS states that in order for dividend income to qualify for the reduced capital gains tax rates two guidelines must be met. Both the company paying the dividend and the holding period relative to the ex-dividend date must qualify.

GainsKeeper's DivTracker product is an easy to use tool that removes the complicated qualified dividend calculations. Taxpayers can use DivTracker to produce a Qualified Dividend Report displaying their ordinary dividend and qualified dividend income - figures required for tax filing in line 9a and 9b of IRS form 1040.

Wash Sale Rule

Definition of Wash Sale Rule

A wash sale is trading activity in which shares of a security are sold at a loss and a substantially identical security is purchased within 30 days. The subsequent purchase could occur before or after the security is sold, creating a 61-day window that must be monitored to identify wash sales.

IRS Explanation of Wash Sales

The IRS defines a wash sale as "a sale of stock or securities at a loss within 30 days before or after you buy or acquire in a fully taxable trade, or acquire a contract or option to buy, substantially identical stock or securities." The wash sale rule under Section 1091 of the Internal Revenue Code (IRC) is intended to prevent investors from generating and recognizing artificial losses in situations where they do not intend to reduce their holdings in the securities that are sold. For purposes of Section 1091 wash sales occur when an investor realizes a loss on the sale of a security and the investor acquires a "substantially identical" security within a 61-day "window" that extends from 30 days before the date of the sale to 30 days after the date of the sale. If an investor sells the stock at a loss, and then buys a "substantially identical" replacement stock within this 61-day window, a wash sale occurs and the loss is deferred until the replacement shares are sold. The pro rata loss is added to the cost basis of the replacement shares purchased, and the holding period of the replacement shares includes the holding period of the original shares sold. However, the deferred loss will eventually be recognized when the replacement shares are sold. For more information about the IRS and the wash sale rule, please see IRS Publication 550.

Wash Sale Example

An investor buys 100 shares of Yahoo stock for $5,000 on October 1. On December 7 the investor sells these 100 shares of Yahoo stock for $4,500. On December 16 the investor buys 100 shares of Yahoo for $4,750. Because the investor bought substantially identical stock within 30 days of the sale of Yahoo, a wash sale occurred and the loss of $500 on the sale of Yahoo cannot be deducted. The loss is deferred and applied to the cost basis of the new tax lot. Therefore, the wash sale in this example would raise the cost basis of the new lot from $4,750 to $5,250.

If you sell a stock and your spouse (if filing jointly) or a corporation you control buys a substantially identical stock, you also have a wash sale. In these cases, the IRC states that losses from the sale of stock can not be recognized at the time of sale, but must be deferred instead.

Wash sales can span tax years. For example, if you sold a stock for a loss in December and repurchased the stock the following January you would have a wash sale. For this reason it is important to include all January trades when calculating your capital gains for the Schedule D.

Wash sales can be very complicated to monitor. To see how GainsKeeper can help investors monitor wash sales, please see the example in "How GainsKeeper Helps Investors Tame Wash Sales."


What the Wash Sale Rule Really Means to Investors

If you are active in a particular stock, it is imperative that you monitor your wash sales period before you re-purchase the stock. After you have taken a loss, you need to be aware of the date you can repurchase a security and still claim the earlier loss on taxes. Investors may find themselves not being able to realize significant losses due to wash sales. Manually tracking the wash sale periods or using a portfolio service such as GainsKeeper that can account for wash sales, will prevent you from purchasing the stock in a wash sale period. Nothing is more frustrating than selling stock at a loss to offset your tax bill only to find out after January 1st that a wash sale disallowed the loss.

While you will eventually realize losses deferred by wash sales, avoiding them in the first place will help you maximize your investment performance.

How to Avoid Wash Sales

Wash sales can be avoided by waiting to repurchase replacement shares until after the 30-day window closes.

You can also avoid a wash sale by purchasing a similar security, rather than an identical stock, to the one you sold for a loss. For example, if you sold Yahoo for a loss and you were interested in investing in another portal stock, then you could buy Google within the 30-day window and not trigger a wash sale.