Because banks have played a traditional role in executing securities transactions in connection with customer trust accounts, this is an area of vital interest to the banking industry. This article presents some basic concepts and illustrations of how the rules work.
Cost basis represents the shareholder's actual capital investment in the corporation.
When the stock is sold, the law allows the recovery of that investment tax-free by granting an offset against any taxable proceeds received. Tax is due only on the increase in value of the stock over the basis. The initial cost basis may need to be adjusted over time. Stock market investors and fiduciaries who handle their accounts need a simple understanding of the rules for adjusting basis when the original cost basis of their stock has been affected by certain corporate actions, such as stock splits, and the investor later sells that stock. The most common type of stock split involves a shareholder receiving the same type of stock as the stock upon which the dividend was declared, e.g., common on common.