Issuing new stock pro rata to those already holding stock of the same company; the new stock to be the equivalent of profits earned by the corporation which are to be retained as additional capital rather than to be paid to stockholders as a cash dividend. For example: a company of $500,000 capital stock has gradually accumulated $100,000 in profits - very likely having paid reasonable dividends in the meantime - and finding its business of sufficient magnitude to warrant the retaining of the $100,000 for use in carrying on its affairs, and, at the same time, wishing to satisfy the stockholders, who, perhaps, had been asking for its division, decides to issue $100,000 in new stock, making a total capital of $600,000. Of course the $100,000 "profits" on the books of the company disappear under that heading, but "capital" account is increased that much. By this method, the $100,000 capital stock becomes fully paid, for had the amount been paid out to the stockholders as a dividend, and they, in turn, paid it back in to the company for new stock, the same result would have been accomplished.
Supposing the par value of each original share to be $100, then, as $100,000 is one fifth of $500,000, each holder of five shares of original stock would receive, without cost, one share of new stock, and a "stock dividend" would have been declared. One of the most notable examples of the declaration of "stock dividends" has been that of the Pullman Co.
The recipient of a stock dividend must not consider himself richer than before, although the market quotations of the stock may appear to make him so. His ownership in the corporation is no greater, as his proportionate interest in the entire capital is the same as previous to the declaration of the stock dividend.
The U. S. Supreme Court in 1919 decided that stock dividends are not to be regarded as income and hence not subject to Federal Income Taxes. In Massachusetts, stock dividends as a result of a decision of the State Supreme Court in 1917 are regarded as income, but are by statute made tax exempt. It is difficult to follow the reasoning of Judge Rugg's decision as the stockholder's proportionate ownership has not increased. This is particularly obvious in the case of dividends in stock without par value when the surplus is not capitalized but remains the same.