Key takeaways
– A “non‑taxable distribution” (also called a non‑dividend distribution or return of capital) is a payment to shareholders that represents a return of part of their invested capital rather than corporate earnings.
– The distribution is not taxed when received; instead it reduces your cost basis in the shares. Tax is generally deferred until you sell the shares, at which point the adjusted basis is used to compute capital gain or loss.
– If cumulative non‑dividend distributions exceed your basis in the stock, the excess is treated as a capital gain in the year the excess is distributed.
– Non‑dividend distributions are normally reported in Box 3 (“Nondividend distributions”) on Form 1099‑DIV. Brokers may adjust basis for you, but you should keep records and verify adjustments.
What is a non‑taxable distribution?
A non‑taxable distribution is a corporate payment to shareholders that is not paid out of earnings and profits. Because it is a return of capital (your own money coming back), it is not treated as taxable dividend income when distributed. Instead, it reduces the taxpayer’s basis in the investment. Other common names: non‑dividend distribution, return of capital (ROC).
Common examples
– Return of capital from a corporation or mutual fund.
– Stock dividends or stock splits (generally not taxable when distributed; they change share count and per‑share basis).
– Stock received in certain corporate spinoffs (may be tax‑free under specific rules).
– Dividends from participating whole‑life or other cash‑value life insurance policies (typically treated as a return of premium up to basis).
How it works — basis adjustment and timing of tax
– When you receive a non‑dividend distribution, you subtract the distribution amount from your cost basis in the security.
– No tax is due at the time of receipt (unless the distribution exceeds your basis).
– When you later sell the security, capital gain or loss is calculated using the adjusted basis.
Example 1 (simple): You buy 100 shares for $800 (basis = $800). The company issues a $90 return of capital to you during the holding period. New basis = $800 − $90 = $710. If you later sell the shares for $1,000, your capital gain = $1,000 − $710 = $290 (which includes the $90 return of capital).
Example 2 (distribution exceeds basis): Same initial purchase ($800). Over time you receive total non‑dividend distributions of $890. Reduce basis to zero with the first $800. The remaining $90 is a capital gain in the year it was distributed (short‑ or long‑term depending on holding period).
How distributions are reported
– Brokers and issuers typically report non‑dividend distributions on Form 1099‑DIV, Box 3 (“Nondividend distributions”).
– If a distribution is not reported as a non‑dividend distribution by the payer, other reporting rules may apply; always check that Form 1099‑DIV details match your records.
– When you sell shares after basis has been adjusted, you report the sale on Form 8949 (if required) and Schedule D of Form 1040, using the adjusted cost basis to compute gain or loss.
Practical steps for investors (checklist)
1. Identify the distribution type and amount
– Review issuer notices and your brokerage’s tax statements. Look for “non‑dividend distribution,” “return of capital,” or Box 3 on Form 1099‑DIV.
2. Adjust your cost basis immediately
– Subtract the ROC amount from your cost basis in the security for the year received.
– If you hold multiple lots, apply the distribution according to how your broker/account tracks lot basis (FIFO or specific‑identification if you elect it).
3. Track cumulative return of capital
– Maintain a running total of ROC received per lot/security. If cumulative ROC equals your basis, future ROC will be taxable as capital gain when distributed.
4. Confirm broker basis adjustments
– Many brokers will update cost basis for you (especially for “covered securities” purchased after certain dates). Verify that their adjusted basis matches your records.
5. Report any excess ROC as capital gain
– If ROC in a year or cumulatively exceeds basis, report the excess as capital gain on Form 8949 and Schedule D.
6. Report sales using adjusted basis
– When you sell shares, use the adjusted basis to calculate your gain/loss. Include transactions on Form 8949 and Schedule D as required.
7. Keep documentation
– Keep 1099s, issuer notices, broker statements, and your basis calculations for at least the IRS recommended period (typically 3–7 years).
8. Seek help for complex situations
– Spinoffs, partial liquidations, or corporate reorganizations can have special tax rules. Consult a tax professional if unsure.
Special situations and additional notes
– Mutual funds: A mutual fund may report part of a distribution as a return of capital. The fund should state this on the 1099‑DIV and provide an explanation. The ROC reduces the tax basis of your mutual fund shares.
– Stock splits and stock dividends: Generally not taxable events; they change the number of shares and adjust per‑share basis so total basis remains the same.
– Corporate spinoffs: Under certain IRS rules (for example, Section 355), stock received in a qualifying spinoff may be tax‑free to shareholders. The tax consequences depend on the specific transaction and should be verified with issuer communications and counsel.
– Life insurance dividends: Dividends from participating whole‑life policies are generally a return of premiums up to the policyholder’s basis; amounts above basis can be taxable. Check the insurer’s tax statement.
– If distribution exceeds basis in a single year: Report the excess as capital gain in that tax year.
– Broker reporting: Brokers may adjust basis automatically, but errors occur. Reconcile broker‑provided adjusted basis with your own records before filing.
Where to report on your tax return
– Form 1099‑DIV, Box 3 reports nondividend distributions.
– Sales of securities are typically reported on Form 8949 (showing per‑transaction adjustments and basis) and summarized on Schedule D (Form 1040).
– If a non‑dividend distribution exceeds basis and creates a capital gain in the year of distribution, include that gain on Schedule D as required.
Common pitfalls to avoid
– Failing to reduce basis when ROC is received — this overstates future taxable gain.
– Relying blindly on broker basis adjustments — reconciliate with issuer information and your own records.
– Not tracking ROC cumulatively across years and lots — you could miss when ROC has exhausted basis and becomes taxable.
– Ignoring 1099‑DIV details or assuming all distributions are ordinary dividends.
Resources and official guidance
– Investopedia: “Non‑Taxable Distribution” — explanation and examples (source provided by request).
– IRS Publication 550, Investment Income and Expenses — guidance on dividends and returns of capital: https://www.irs.gov/pub/irs‑pdf/p550.pdf
– IRS Form 1099‑DIV instructions — explains Box 3 reporting: https://www.irs.gov/forms‑instructions
– IRS Form 8949 and Schedule D instructions — reporting sales and capital gains: https://www.irs.gov/forms‑instructions
Bottom line
A non‑taxable (non‑dividend) distribution is usually a return of capital that defers taxation by reducing your cost basis in the investment. It is essential to track these distributions, adjust your basis, confirm broker reporting, and report any excess distributions as capital gain in the appropriate year. When in doubt—especially for spinoffs, large distributions, or complex reorganizations—consult a tax professional.