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Hi,

I have what I hope is an interesting question based on the notion of buying a stock just for a special dividend payout. Looked through the FAQ and could not find an answer. If there is one, please point me to it.

Ameritrade recently paid a \$6 special dividend and I would like to understand some tax implications for this. There is an explanation on Ameritrade's website under their FAQ (http://www.amtd.com/investors/faq.cfm -- click on FAQ #1), but it is not entirely clear to me.

Here's my attempt at an explanation. Could someone please tell me if I've got it right or not and, if not, what is really happening?

For initially buying below the selling price:
You buy at \$16 and watch the stock rise to \$25. On the ex-div date, the price drops to \$19 because of the dividend. You later sell at \$19.50. Suppose \$2 of the \$6 is determined to be dividend, as described by Ameritrade. You owe tax on that as either qualified or non-qualified dividend, depending on your holding period (rule in IRS Pub 550). The remaining \$4 is taxed as capital gain at a rate determined by your holding period. In addition, you owe tax on \$3.50 of capital gain for the sale above your buy price (\$19.50 - \$16 = \$3.50), at a rate depending on your holding period (long or short term).

For initially buying above the selling price:
Same situation, but this time, the buy price is \$22 instead of \$16. The stock rises to \$25. On the ex-div date, the price drops to \$19 because of the dividend. You later sell at \$19.50. You owe tax on the \$2 determined to be dividend, as above. The remaining \$4 is taken up as follows: \$2.50 is used to recover to your "pro rata" share of Ameritrade at \$22 (\$19.50 - \$22 + \$2.50 of remaining \$4 = zero). The remaining \$1.50 of that \$4 would be taxed as capital gain.

For buying too high:
Same situation, but this time, the buy price is \$26 instead of \$22 or \$16. Stock falls to \$25 and drops to \$19 on the ex-div date. You sell at \$19.50. Pay tax on the \$2 dividend, as above. Have a capital loss of \$2.50 (\$19.50 - \$26 + remaining \$4 = neg \$2.50) and no tax owed on that portion of the \$6 special dividend.

gebin
No. of Recommendations: 2
I have what I hope is an interesting question based on the notion of buying a stock just for a special dividend payout. Looked through the FAQ and could not find an answer. If there is one, please point me to it.

Ameritrade recently paid a \$6 special dividend and I would like to understand some tax implications for this. There is an explanation on Ameritrade's website under their FAQ (http://www.amtd.com/investors/faq.cfm -- click on FAQ #1), but it is not entirely clear to me.

Here's my attempt at an explanation. Could someone please tell me if I've got it right or not and, if not, what is really happening?

For initially buying below the selling price:
You buy at \$16 and watch the stock rise to \$25. On the ex-div date, the price drops to \$19 because of the dividend. You later sell at \$19.50. Suppose \$2 of the \$6 is determined to be dividend, as described by Ameritrade. You owe tax on that as either qualified or non-qualified dividend, depending on your holding period (rule in IRS Pub 550). The remaining \$4 is taxed as capital gain at a rate determined by your holding period. In addition, you owe tax on \$3.50 of capital gain for the sale above your buy price (\$19.50 - \$16 = \$3.50), at a rate depending on your holding period (long or short term).

For initially buying above the selling price:
Same situation, but this time, the buy price is \$22 instead of \$16. The stock rises to \$25. On the ex-div date, the price drops to \$19 because of the dividend. You later sell at \$19.50. You owe tax on the \$2 determined to be dividend, as above. The remaining \$4 is taken up as follows: \$2.50 is used to recover to your "pro rata" share of Ameritrade at \$22 (\$19.50 - \$22 + \$2.50 of remaining \$4 = zero). The remaining \$1.50 of that \$4 would be taxed as capital gain.

For buying too high:
Same situation, but this time, the buy price is \$26 instead of \$22 or \$16. Stock falls to \$25 and drops to \$19 on the ex-div date. You sell at \$19.50. Pay tax on the \$2 dividend, as above. Have a capital loss of \$2.50 (\$19.50 - \$26 + remaining \$4 = neg \$2.50) and no tax owed on that portion of the \$6 special dividend.

Your calculations correct but far too complex and all of the intermediate price changes are irrelevant to the calculations. If you assume that \$2 of the dividend is ordinary qualifying dividend and the remaining \$4 is return of capital, all you do is subtract \$4 from your cost basis when you calculate your gain or loss on sale.

For situation 1 -- you pay tax on the difference between 16-4=12 and \$19.50 --> \$7.50 capital gain.

For situation 2 -- you pay tax on the difference between 22-4=18 and \$19.50 --> \$1.50 capital gain.

For situation 3 -- you pay tax on the difference between 26-4=22 and \$19.50 --> \$2.50 capital loss.

Ira
No. of Recommendations: 0
all you do is subtract \$4 from your cost basis when you calculate your gain or loss on sale

Hi Ira,

Thank you for your reply. That's what I thought and I did realize the net effect was to lower the basis. However, the wording of the text on Ameritrade's site led me to the more convoluted resolutions of the situations.

Any portion of the special dividend in excess of each holder's pro rata share of TD AMERITRADE's earnings and profits will be treated first as a tax-free return of capital up to each holder's basis in its shares of TD AMERITRADE common stock, with any remainder treated as a capital gain.

gebin
No. of Recommendations: 0
However, the wording of the text on Ameritrade's site led me to the more convoluted resolutions of the situations.

Just for completeness, I'll point out the issue Ameritrade is dancing around. One more example.

Bought for \$3.50. Got the \$4 return of capital. Subtract the \$4.00 off the \$3.50 and -- whoops -- our basis is negative. So instead of having a negative basis, you recognize capital gain of .50 per share and have a basis of zero.

--Peter
No. of Recommendations: 0
Any portion of the special dividend in excess of each holder's pro rata share of TD AMERITRADE's earnings and profits will be treated first as a tax-free return of capital up to each holder's basis in its shares of TD AMERITRADE common stock, with any remainder treated as a capital gain.

Right. If you purchased the stock for less than \$4/share, you'd recognize some gain.

Ira
No. of Recommendations: 0
Hi Peter,

Thanks for the additional comment.

One more scenario. Suppose 100% of the special dividend is declared to be a dividend and there is no return of capital. Bought at \$22 before the stock went ex-div, sold at \$19.50 after ex-div. Could this person recognize a \$2.50 capital loss?

Thanks,
gebin