Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What is the tax consequence for an investor who receives a stock dividend?

1. It creates a taxable event immediately

2. It is taxable only when the stock is sold

3. It reduces the cost basis of the stock

4. It has no tax implications

The correct answer is: It is taxable only when the stock is sold

When an investor receives a stock dividend, the correct understanding is that it is not taxed at the time of receipt. Instead, the tax obligation is deferred until the stock is eventually sold, which aligns with the choice that states it is taxable only when the stock is sold. This approach to stock dividends is rooted in the general principle of tax deferral for equity investments. Essentially, stock dividends involve the issuance of additional shares rather than cash, meaning the actual capital gain or taxable event occurs only when those shares are disposed of or sold. At that point, any increase in value from the original investment may be subject to capital gains tax. To further clarify, the other options either imply immediate tax consequences or a reduction in basis that mischaracterizes how stock dividends function for tax purposes. Understanding the concept of deferring taxes until a sale helps investors manage their tax liabilities effectively.