What tax treatment applies to a shareholder participating in a common stock's dividend reinvestment program?

When a shareholder participates in a common stock's dividend reinvestment program, the tax treatment is that the shareholder is treated as if they received a cash dividend equal to the fair market value of the shares purchased under the plan. This means that even though the dividends are reinvested rather than paid out in cash, the IRS considers it as a taxable dividend distribution to the shareholder.

The key aspect of this treatment is that the fair market value of the new shares actually acquired through the reinvestment is treated as taxable income in the year the dividend was reinvested. Consequently, the shareholder must report this value as income on their tax return, which reinforces the principle that dividends, whether received in cash or through reinvestment, are generally subject to income tax.

This approach ensures that shareholders are taxed appropriately and maintains consistency in how dividends are treated for tax purposes, despite the method of receiving those dividends.