Stock rights can include any intangible that gives a shareholder the option to buy additional shares in the corporation, whether it’s called a right, an option, or a warrant for purposes of the tax-free treatment for a corporation’s distribution of rights to its stock. However, the right to convert a bond to stock does not make the bond a nontaxable stock right[i].
I.R.C. Sec. 305(a) provides that when a corporation distributes to its shareholders its own stock or rights to buy its stock, that distribution is not taxable to the shareholders. Pursuant to Treas. Reg. § 1.317-1, if a corporation distributes stock of, or rights to buy stock in another corporation, the distribution is taxable under the dividend rules, even if the corporations are affiliated. I.R.C. Sec. 305(f) provides that the stock dividend rules do not apply to stock or rights received in connection with corporate organizations, reorganizations, or divisions.
26 U.S.C.S. § 27 provides in part that in case of a stock dividend or stock right which is a taxable dividend in the hands of shareholders under 26 U.S.C.S. § 115 (f), the dividends paid credit with respect thereto shall be the fair market value of the stock or the stock right at the time of the payment. If any part of a distribution, including stock dividends and stock rights, is not a taxable dividend in the hands of such shareholders for the period in which the distribution is made, no dividends paid credit shall be allowed with respect to such part[ii].
[i] Choate, Arthur v. Com., (1942, CA2) 29 AFTR 965, 129 F2d 684, 42-2 USTCP 9555.
[ii] Okonite Co. v. Commissioner, 4 T.C. 618 (T.C. 1945)