What Are Accumulating Shares?
Accumulating shares is a classification of common stock given to shareholders of a company in lieu of, or in addition to, a dividend. By taking accumulating shares instead of cash dividends, shareholders don't have to pay income tax on the distributions in the current year. However, it is still mandatory to pay capital gains tax, if any, in the year when the shares are sold.
Sometimes companies pay out these types of shares in addition to cash dividends in the form of stock dividends.
- Accumulating shares is a compensation given to employees or shareholders in the form of stock rather than cash, often for beneficial tax purposes.
- Employee bonuses paid in stock are sometimes preferred as they defer tax liability to the time of sale.
- Stock dividends are also a form of accumulating shares that give shareholders the same tax-deferred benefit.
Understanding Accumulating Shares
A company's board of directors decides whether to pay dividends, how much and in what form. In almost all cases, dividends are paid in cash mainly because investors expect it.
This is particularly true for stocks that are relied upon by investors for regular income. In some cases—for example, when a company wants to preserve cash on its balance sheet—accumulating shares are given to existing shareholders.
Another reason for distributing these shares is to increase the number of outstanding shares, thereby boosting the liquidity in the public market. It is important to note that existing shareholders will not suffer dilution of their holdings because the shares are going to them instead of other investors. They retain proportional stakes in the company.
Accumulating shares are also a feature of mutual funds. A mutual fund investor is usually given the choice between receiving income distributions in cash from the fund or reinvesting the income back into the fund. If the investor opts for reinvestment, the income is used to purchase additional shares in the fund.
Generally speaking, because equity prices tend to rise over time, the common money wisdom is to accept accumulating shares instead of cash dividends if you have a long time horizon and do not depend on dividend income for daily living expenses.
Also known as a "scrip dividend," a stock dividend is a distribution of shares to existing shareholders in lieu of a cash dividend and is thus a form of accumulating shares. This type of dividend arises when a company wants to reward its investors but either doesn't have the capital to distribute or it wants to hold onto its existing liquidity for other investments.
Stock dividends also have a tax advantage in that they aren't taxed until the shares are sold by an investor. This makes them advantageous for shareholders who do not need immediate capital.
If a stock dividend has a cash-dividend option, even if the shares are kept instead of the cash, taxes will be due.
The board of a public company, for example, can approve a 5% stock dividend, which gives existing investors an additional share of company stock for every 20 shares they already own. However, this means that the pool of available equities increases by 5%, diluting the value of existing shares.
Therefore, in this example, even though an investor who owns 100 shares in a company may receive 5 additional shares, the total market value of those shares remains the same. In this way, a stock dividend is very similar to a stock split.