Surprise! You Got More Than Just OSH Shares from the SHLD Spinoff
Laurie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Members of a bivio investment club who own Sears Holdings (NASDAQ: SHLD) recently asked us how to make the entries to record the shares they were receiving in spinoff company Orchard Supply Hardware Stores (NASDAQ: OSH).
When a reorganization occurs, we research the details so that clubs can update their records correctly. This is especially important with the new cost basis reporting rules phasing in. Starting with this tax season, cost basis will be reported by brokers to the IRS when you sell an investment, giving the IRS a way to double check what you report as capital gains and losses. In a spinoff, your cost basis in the original stock you own gets divided up. Part of it stays with the parent company and part is transferred to the new shares you receive.
Sometimes companies post easy-to-read descriptions of the spinoff details and the tax considerations in the investor relations sections of their websites. In other cases, such as this one, we had to go to the actual SEC form S-1 prospectus filing to get the information needed.
In this spinoff, for every 22.141777 shares (you get your money's worth of decimal places) of Sears Holdings Common stock you held as of the close of business on Dec. 16, you received 1 share of OSH Class A Common stock and 1 share of OSHSP (OTCQB: OSHSP) Preferred stock.
You only receive whole numbers of shares. For any fractions that you are owed, you receive what is called cash-in-lieu. This is where this spinoff gets interesting, and this is where a thorough reading of the prospectus was important. Cash-in-lieu is normally treated as a sale of the fractional share. With it comes a tiny capital gain to report.
In this case, it turns out that the Preferred shares being distributed have triggered special treatment under Section 306 of the tax code. Not to go into too many details, but section 306 was established a long time ago to prevent companies from distributing profits as Preferred stock rather than dividends. At the time, it was advantageous to do this to avoid a high tax rate on dividends. If you want to know more details, here's the story of how and why it came about.
If Preferred stock is determined to be "Section 306" stock, as the OSHSP Preferred apparently was, it triggers special treatment when it is sold. In this spinoff, this happens immediately if you are owed fractional shares and will receive cash-in-lieu. It will be treated and taxed as the receipt of a dividend rather than as the sale of a fractional share of stock.
When you sell the rest of the shares you received, there are all kinds of hoops to jump through to determine how to report the sale on your tax forms. What you report will depend on the circumstances of the sale. It's straightforward if you sell all your Preferred shares along with all the Common stock you received. You can treat both sales like any other stock sale and you'll just have regular capital gains and losses to report.
But, if you sell the Preferred shares independently from the Common, everything changes. Part of your proceeds will be reported as ordinary dividend income and only part may be reported as capital gains income. The amount treated as ordinary income is the fair market value of the shares on the date they were distributed. This can be calculated several ways. For example, you can use the opening price on the date the stock began trading, the closing price or the average of the high and low for the day. OSHSP trades on the OTC market. On its first trading date, it opened at $.45 and closed at $1.65. Pick what you’d like as the “Fair Market Value.”
If you sell the stock for more than the amount you have to report as dividend income, you still might have a capital gain. You figure that out by adding the dividend amount to your cost basis in the shares. Subtract the total from the proceeds of your sale. If you have a gain, you report it as long-term or short-term capital gain. No luck if you have a loss. For this kind of stock, you're not allowed to claim that.
Because of the new cost basis reporting rules, you'd like what you report as a gain to match up with what your broker reports on your 1099s. Brokers will be making a valiant attempt to report things correctly, but situations such as this certainly don't make their already complicated job any easier. As you can see, the amount of gain you need to report will depend on what you decide will be the amount reported as a dividend, which will depend on what you choose as a fair market value.
So, all you were merrily doing was trying to be an individual investor, and you've gotten caught in the quagmire of the tax code. Did you own enough SHLD to justify hiring a CPA to help you figure this out so you can file your taxes correctly? Like many of us in these cases, you probably did not. Even if you do, it's an obscure area of the tax code. The little "tax advisor" we are all supposed to have in our pocket might not be up to speed on the details of how to handle this specific tax issue. He's got an awful lot of other things to try and keep straight.
Is anybody out there listening? We're individual investors. We'd like to be able to participate in the equity markets without fear of triggering tax issue landmines that will wipe out our gains with tax preparation costs. Isn't there some sort of materiality cutoff that can be applied to whether we have to jump through every hoop to try and comply with the tax code?
I am the COO of www.bivio.com I have no positions in the stocks mentioned above.
Each person's tax situation is unique. If you have any questions, you should consult a tax advisor to make sure you understand the exact effect of any transactions on your personal finances.
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