If a company merges, splits stock or pays a stock dividend, it declares that stockholders will receive a certain number of shares based on the number they already own. If the math doesn't work out to a whole number, the company distributes fractional shares. Most of the time, stockholders receive "cash in lieu," or the monetary market value of the share fraction, rather than the fractional shares themselves. For tax purposes, this is treated as a receipt and a sale, and you'll owe tax on any capital gain. Exactly how you report this gain on Schedule D of your 1040 from depends on the origin of your fractional shares.
Determine what event resulted in your fractional shares. In industry lingo, this is called a "corporate action" and may be a stock split, merger, reorganization or dividend. You can find this information in the paperwork you received from the issuing company, or on the company website -- look for "investor information," often under the "about us" section of the website.
Calculate your cost basis. For most splits, you'll assign your fractions a basis based on the average cost per share: the value of all purchases plus commissions and fees divided by the number of shares you hold, including fractions. Other corporate actions may use this method, or they may treat the whole fraction as gain, which means your cost basis is zero.
Subtract your cost basis from the value of your cash in lieu. This is your taxable gain.
Combine your gain with any other similar gains you have for the year -- long term gains from sales of assets held for more than 12 months, qualified dividends and other qualified actions are taxed at the preferred capital gain rate, while other transactions are taxed as ordinary income.
Write the total value of your long and short term gains into the appropriate spaces on the IRS Schedule D.
If your gain calculation results in a negative number, you actually have a loss -- most likely to occur with stock splits. As with gains, you can combine this loss with other losses to offset any long term capital gains and lower your tax bill.