On Friday, Congress passed the Inflation Reduction Act of 2022, which includes a new 1% tax on certain corporations that repurchase (buy back) their stock from their shareholders. The corporations subject to this new tax are domestic corporations traded on an established securities market and certain foreign corporations. The text of the bill leaves open certain questions, including whether various transactions will be subject to the tax. The tax applies to buybacks occurring on or after Jan. 1, 2023.
Summary of the new provision
On Friday, Aug. 12, 2022, Congress passed the Inflation Reduction Act of 2022, and the President stated he will sign it into law shortly. Among other provisions, the Act includes an excise tax on certain corporations that repurchase (buy back) their corporate stock. The tax would be equal to 1% of the value of any stock bought back, based upon the fair market value of the stock, subject to an adjustment, as described below.
The corporations subject to the tax are domestic corporations traded on an established securities market (“covered corporation”), as well as certain foreign corporations, as discussed below. The scope of transactions subject to the tax is relatively broad; it applies where either (a) a covered corporation acquires its stock from a shareholder in exchange for property (as per section 317(b)), or (b) any other economically similar transaction. The tax applies whether or not, following the buyback, the corporation cancels, retires or holds onto the stock as treasury stock.
The tax would cover not only repurchases by the covered corporation itself, but also acquisitions of the covered corporation’s stock by “specified affiliates” of the corporations. These specified affiliates are (1) a corporation that is more than 50% owned (by vote or value), directly or indirectly, by the covered corporation, or (2) a partnership in which the covered corporation holds, directly or indirectly, more than 50% of the capital or profits interests. Under this rule, for example, if a publicly traded corporation (parent) owns more than 50% of the stock of a subsidiary, and the subsidiary repurchases parent stock from a shareholder of the parent, the tax would apply.
As mentioned above, the tax also applies to the acquisition of stock of certain foreign corporations that are traded on an established securities market, when a specified affiliate of the foreign corporation (generally a domestic subsidiary) acquires the stock from a person other than the foreign corporation or another specified affiliate. In this case, the specified affiliate is treated as a covered corporation and the acquisition is deemed a repurchase of stock of a covered corporation by such covered corporation. Additionally, the tax applies to repurchases by foreign corporations that are “surrogate foreign corporations,” as per the section 7874 inversion rules (relating to a foreign corporation that acquires the assets of a domestic corporation or partnership).
Notably, the amount taxed is reduced by the fair market value of any stock issued by the covered corporation during the taxable year, including stock issued as compensation and stock issued in response to the exercise of an option to purchase company stock. Payments made under the tax are not deductible for federal tax purposes.
A repurchase is not subject to the excise tax where:
- the repurchase is part of a tax-free reorganization where no gain or loss is recognized.
- the repurchased stock or its value is then contributed to an employee pension plan, ESOP, or similar plan.
- the total amount of repurchases within the year does not exceed $1 million.
- the purchaser is a dealer in securities in the ordinary course of business.
- the purchaser is a RIC or REIT.
- the repurchase is treated as a dividend.
The tax applies to buybacks occurring on or after Jan. 1, 2023. The Act provides authority for the Treasury Department to issue regulations and other guidance necessary to prevent the avoidance of the tax.
The text of the statute leaves open several questions.
- One significant question relates to the exception involving a repurchase treated as a dividend. The Tax Code provides in section 302 that whether a corporation’s stock redemption is treated as a dividend depends on various factors. However, corporations often do not seek to determine whether a particular redemption is treated under section 302 as a dividend (that inquiry is often undertaken by the relevant shareholders). A corporation that wishes to obtain the benefit of the excise tax’s dividend exception will need to perform a section 302 analysis, but the corporation may at times not have easy access to the information necessary to perform a section 302 analysis.
- Additionally, as noted above, aside from ordinary stock redemptions (as defined under section 317(b)), transactions that are “economically similar” to redemptions are subject to the tax. The term “economically similar” is vague and could potentially draw in various forms of M&A transactions. For example, a leveraged buyout involving a target that takes out debt to pay off the selling shareholders could in certain circumstances arguably trigger the excise tax.
- Another open question relates to the first exception, which states that the tax does not apply to certain tax-free reorganizations unless there is gain or loss recognized (i.e., where the exchanging shareholders receive cash (boot) in the exchange). It is not entirely clear how the exception should be interpreted in a case where there is boot in excess of the taxable gain.
Hopefully, Treasury and the IRS will release regulations or guidance to provide clarity on these issues.