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Tuesday, 01/21/2003

Accurate Record keeping is a necessity for Dividend Reinvestment Plans (DRIPS)
by Steve Gail

Getting a Dividend Investment plan started, often requires very little to get initiated. The transfer agent of your selected stock just takes your dividends every quarter and reinvests them into more shares and if you are involved in an optional cash purchase plan with automatic investment option, you have that cash amount invested in additional shares as well. What could be easier? Well, you and I both know, that would be just too simple. DRIP plans, just like any capital investment is subject to taxes. In the case of dividends, ordinary income, and in the case of cash, the establishment of a new cost basis for the newly acquired shares to eventually determine capital gains or losses). Now lets do a little math here. A stock pays four (4) quarterly dividend periods a year, where dividends could be reinvested to buy more shares, if enough cash is generated from the dividend in any quarter to buy at least 1 full share. (The tax considerations are a topic we will discuss in greater detail in a later article.} However, for this discussion I just want to point out the record keeping requirements that need to be maintained. For anyone of you that is used to reinvesting their dividends back into shares of their Mutual fund, you have a very good idea as to what paperwork is needed to keep accurate records for you DRIP accounts. The other difference is that with DRIP plans, unlike Mutual funds, you may only purchase whole shares. Let's take a look at the paperwork required in a hypothetical DRIP plan that reinvests dividends only: Dividend Reinvestment Plan with quarterly dividends invested only (Since only full shares can be purchased any left over cash was used for purchase of shares when enough cash was accumulated from future dividend payments.)

Exhibit 1: (Please note that you have 5 different dates in the DRIP plan that you are required to keep records for potential tax consequences. - and this assumes only looking at year one (1) year and only looking at a plan that reinvests dividends only, not automatic monthly cash purchases.)

The exhibition above shows an investor who started out buying 50 shares of a $10 stock. The stock pays $0.60 dividend annually or $0.15 a share quarterly. All dividends are used to purchase additional shares and any cash left over is held until next dividend pay period and used with the next dividend to buy more shares. Once again, if any cash is left over it will be used with the next dividend payment to purchase shares. The example above shows an accumulation of 5 additional shares with 4 separate cost basis and established purchase dates for establishing holding periods for tax consequences for future sales.

Now if you take it one step further and add the automatic optional cash purchases to the DRIP, you could add potentially, twelve (12) monthly automatic cash purchases from your checking account to purchase additional shares, and just like that you are looking at potentially sixteen (16) total transactions that would all have different dates from which to determine cost basis from. Each of these transactions establishes a holding period and a cost basis that will be eventually used to a determination of any subsequent capital gain or loss for future tax consequence. These cash purchases have their own cost basis over and above your dividend reinvestments which also purchase new shares, with new holding periods and cost basis, but are currently taxed as ordinary income. (The tax considerations and future changes in tax consequences on dividends are a topic we will also discuss at a later time in greater detail.)

As one can see, the record keeping process could get out of hand if an investor doesn't keep on top of it constantly, especially if you are making automatic purchases for additional shares for your DRIP as well. Later this week we will discuss tax consequences of dividends and current legislation that could have an effect on how these DRIP dividends are treated in the very near future.

Until next time,


Copyright 2003

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