A bonus issue of shares is a free, pro-rata distribution of additional stock to existing shareholders, funded by moving money from a company’s retained earnings or reserves into share capital. You get more shares without paying anything, the price per share drops proportionally so your total holding value stays the same, and for a standard distribution of common stock to common shareholders, the IRS does not treat the receipt as income. Tax enters the picture only when you sell, and the cost basis of your original shares is spread across the enlarged holding.
Who Qualifies to Receive the Shares
The company sets a record date. If your name is on the shareholder register that day, you receive the bonus shares. If it is not, you receive nothing, no matter how long you owned the stock before or how long you keep it after.
The market-side cutoff is the ex-bonus date. Since the U.S. moved to next-day (T+1) settlement in May 2024, the ex-date for distributions is generally the same day as the record date rather than one business day earlier.1Nasdaq. Issuer Alert 2024-1 Buy on or after the ex-date and the seller keeps the entitlement, because your trade will not settle in time to put you on the register. Watch this window closely if you are buying near the announcement.
How the Ratio Translates to Shares You Receive
Companies announce a bonus issue as an “X for Y” ratio. In a 2:1 ratio, you get two additional shares for every one you already hold; 100 shares becomes 300. A 1:5 ratio runs the other way, one new share for every five held, so 100 shares brings you 20 more.
The math is multiplication. Take your shares on the record date, multiply by the first number, divide by the second. A holder of 500 shares in a 3:1 bonus issue receives 1,500 new shares.
Fractional Entitlements
Not every ratio divides evenly into every holding. If you own 75 shares and the ratio is 1:2, your entitlement is 37.5 shares. Since companies rarely issue half a share, the standard practice is to pay cash in lieu of the fraction. Federal regulations permit this where the purpose is to avoid the cost and complexity of issuing fractional certificates.2eCFR. 26 CFR 13.10 – Distribution of Money in Lieu of Fractional Shares The cash-in-lieu payment is generally treated as a sale of the fractional share and can produce a small taxable gain.
What Happens to the Share Price
On the ex-bonus date, the stock price adjusts down to reflect the larger share count. A 1:1 bonus issue roughly halves the price. A stock trading at $100 the day before a 1:1 distribution will typically open near $50 once the adjustment takes effect. Market capitalization is unchanged.
Your portfolio value does not change either. Owning 100 shares at $100 ($10,000) becomes 200 shares at $50 (still $10,000). The adjustment is why a bonus issue is not free money in any economic sense; it is the same value split into more pieces.
Open Orders and Options You Already Hold
Standing limit and stop orders resting with your broker are adjusted for the distribution. Under FINRA Rule 5330, the order price is reduced and the size increased to reflect the ratio, so an old limit price does not fill at what is now an inflated level.3FINRA. FINRA Rule 5330 – Adjustment of Orders Open sell orders and stop orders to buy are exempt from that automatic adjustment.
Options contracts on the stock are adjusted too. For whole-share bonus issues like a 2:1 or 3:1, the Options Clearing Corporation generally increases the number of contracts and proportionately lowers the exercise price, so each contract’s notional value stays intact.4U.S. Securities and Exchange Commission. Self-Regulatory Organizations – The Options Clearing Corporation – Notice of Filing of Proposed Rule Change A call on 100 shares with a $60 strike becomes two contracts on 100 shares each with a $30 strike after a 2:1 distribution. Adjustments take effect on the ex-date.
Tax Treatment of Bonus Shares
Under federal tax law, a pro-rata stock distribution is generally not a taxable event. The statute treats it as a rearrangement of your existing ownership rather than new income.5Office of the Law Revision Counsel. 26 USC 305 – Distributions of Stock and Stock Rights You owe nothing to the IRS when the new shares appear in your account. Tax is deferred until you sell.
When a Distribution Is Taxable Instead
The nontaxable rule has exceptions. A stock distribution is treated as taxable property, like a cash dividend, in any of these cases:
- Any shareholder had the option to take cash in place of stock. If the choice existed, the entire distribution is taxable to everyone who received it.
- The distribution is disproportionate: some shareholders receive cash while others end up with an increased ownership percentage.
- Some common shareholders receive preferred stock while others receive common stock. Both distributions are taxable.
- The distribution is made with respect to preferred stock.
- The distribution consists of convertible preferred stock, unless the company can show it will not produce a disproportionate result.
The common thread is proportionate ownership. If a distribution changes anyone’s percentage or hands some holders property while others get stock, the tax-free treatment disappears.5Office of the Law Revision Counsel. 26 USC 305 – Distributions of Stock and Stock Rights Most ordinary bonus issues, where every common shareholder receives the same ratio of new common shares, remain nontaxable.
How Your Cost Basis Changes
Nontaxable receipt comes with a basis reallocation. Federal law requires you to spread the adjusted basis of your original shares across the old and new shares combined.6Office of the Law Revision Counsel. 26 USC 307 – Basis of Stock and Stock Rights Acquired in Distributions Suppose you paid $1,000 for 10 shares, a basis of $100 each, and received 10 bonus shares in a 1:1 distribution. Your basis becomes $50 per share across all 20 shares. The $1,000 total does not move.
That reallocated basis is what determines your gain when you sell. Sell those 20 shares at $70 apiece and the taxable gain is $20 per share, not $70. Treating bonus shares as zero-basis stock is one of the more expensive mistakes investors make after a distribution.
Holding Period
The clock on your bonus shares runs from when you bought the originals. If you have held the underlying stock for three years and receive bonus shares today, those new shares are already long-term for capital gains purposes.7Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property The tacking rule applies where the new shares take their basis under the allocation rules above, meaning nontaxable distributions. It does not extend to distributions that were taxable at receipt.
The Form You Should Look For
A corporation that takes an organizational action affecting the basis of a specified security, which includes any stock, must file IRS Form 8937 within 45 days of the action, or by January 15 of the following year, whichever comes first.8Internal Revenue Service. Instructions for Form 8937 The company must also provide a copy to each shareholder of record, giving you the figures needed to adjust your basis correctly. Companies can skip the IRS filing if they post a completed Form 8937 on their public website and keep it accessible for 10 years, so if you did not receive one directly, check the investor relations page.
Bonus Issue vs. Stock Split
A bonus issue and a stock split both increase the share count without changing total equity, and from a shareholder’s chair the economic result is the same: more shares, lower price, unchanged total value. The accounting differs. A stock split reduces par value per share proportionally and requires no formal journal entry. A bonus issue leaves par value alone and transfers value from retained earnings to paid-in capital, which shrinks the retained earnings balance. Repeated bonus issues drawing down that reserve can be a signal worth noting when you read a company’s financial statements.