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When clients purchase shares of any American Century® Zero Coupon fund, they are given an anticipated value that the shares will be worth at maturity, if all distributions are reinvested and they hold their shares until the fund is liquidated.
Each year in mid-December, the Zero Coupon fund(s) pay a distribution along with any capital gains earned. When any fund pays a distribution it causes the share price to fall by the distribution amount on the distribution date. In order for the Zero Coupon fund(s) to reach their anticipated share value by its target year, a reverse share split necessary. This allows the fund(s) to distribute a dividend and any capital gains without decreasing the share price.
On the day the dividends and capital gains are distributed, the share price of each Zero Coupon fund drops by the amount of the distribution. Immediately following the distribution, the reverse share split is performed. Each fund's share price is raised to the same level as before the distribution, while the share balance of each account in the fund is reduced proportionally. To accomplish this, each fund calculates a "reverse share split factor" as follows:
Bob and Sue each own 100 shares in a Zero Coupon fund. Bob has his distribution paid to him in cash, while Sue reinvests her distribution.
On the day before the ex-dividend date (the date the dividends and capital gains are paid), the closing share price for the fund is $50, giving Bob and Sue an account value of $5,000. On the ex-dividend date, the fund declares a distribution of $10 per share, causing the share price to drop to $40.
Sue's account value remains the same since she reinvests her distribution, while Bob's drops because he receives his distribution in cash. Bob and Sue must each report dividend/capital gain income of $1,000 on their tax returns.
Then the reverse shared split is performed.
The reverse share split factor is 0.8 ($40 / $50).
Each time a reverse share split is performed, you are allowed adjust your per share cost basis proportionally in order to avoid overpaying on taxes when you sell shares. Essentially you are allowed to perform the reverse share split on your cost basis. For each purchase, including reinvested distributions, reduce the number of shares and increase the share price using the reverse share split factor.
Based on the previous example, suppose Bob and Sue each purchased their 100 shares at $20 per share. Sue also purchased 25 shares at $40 per share when she reinvested her distribution. Using the reverse share split factor (0.8), they would adjust their respective cost basis as follows:
Notice that the total purchase amount does not change; it is only the per-share cost basis that is adjusted. Notice also that the total number of shares after the coast basis adjustment equals the total number of shares owned after the reverse share split (80 for Bob, 100 for Sue).
Please consult your tax advisor for more information on reporting cost basis on your account.
Note: If you own shares in an American Century Zero Coupon fund through your retirement plan [i.e. IRA, 401(k) or 403(b)] or Coverdell Education Savings Account, your distributions are automatically reinvested so the reverse share split will not affect you.
Although you do not receive regular interest payments from zero-coupon bonds, the IRS requires you to pay income tax on the accrued interest each year as if it had been paid to you. This type of interest is referred to as "imputed interest." Taking distributions in cash may affect your account value over time and create unique tax considerations.
Although you can potentially earn a dependable return if you hold your shares to maturity, you should be prepared for dramatic price fluctuations which may result in significant gains or losses if sold prior to maturity.
Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.