Executive Summary: IRS guidance on new 1% stock buyback excise tax
The IRS and Treasury have issued guidance for corporations subject to the new 1% excise tax on stock redemptions (buybacks), enacted Aug. 16 as part of the Inflation Reduction Act and effective for stock repurchases after Dec. 31, 2022. The guidance, contained in Notice 2023-2, provides operating rules for the tax, including whether certain redemption transactions qualify as repurchases, guidelines for determining the fair market value of stock repurchased and rules relating to calculation and reporting of the tax.
Summary of the excise tax as passed into law
The new 1% excise tax on stock redemptions was enacted on Aug. 16 as part of the Inflation Reduction Act and is effective for stock repurchases taking place after Dec. 31, 2022.
Generally, corporations subject to the tax are domestic corporations traded on an established securities market and certain foreign corporations. The scope of transactions subject to the tax is relatively broad; it applies where either (a) the 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 the stock, retires the stock or holds onto the stock as treasury stock. The tax applies to buybacks occurring on or after Jan. 1, 2023.
The tax covers 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. 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.
Notably, under a netting rule, 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 excise 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.
Our prior tax alert on the stock buyback excise tax contains further details and observations regarding the tax upon its passage into law. That Alert raises several questions, many of which were addressed in the recently released IRS interim guidance, but not without uncertainty.
IRS guidance in Notice 2023-2
In Notice 2023-2 (Notice), Treasury and the IRS (i) announced their intention to issue proposed regulations and (ii) provided interim guidance, which taxpayers may rely on until the publication of regulations. While the Notice is broad in scope, our summary below is high-level, focusing on the most relevant issues.
Aside from the rules, many of which are summarized below, the Notice provides twenty-six detailed examples to assist taxpayers with the application of the rules. We anticipate we will provide in the future a more detailed summary of the issues addressed in the Notice.
Highlights of how to compute, report and pay the tax
- The tax is computed by multiplying the excise tax base by 1%. The excise tax base includes the fair market value (FMV) of all the corporation’s stock it repurchased during its taxable year, less (i) the FMV of certain enumerated repurchases and (ii) the FMV of stock issued by the corporation (under the netting rule). Enumerated repurchases include certain (i) reorganizations, (ii) stock contributions to an employer-sponsored retirement plan, (iii) repurchases by a dealer in securities, (iv) repurchases by a RIC or REIT and (v) repurchases treated as a dividend.
- Under a de minimis rule, the tax does not apply when the FMV of the total stock repurchased by the corporation is $1 million or less. However, the de minimis calculation is made before reducing for the enumerated repurchases (listed above) or the stock issued under the netting rule.
- The IRS anticipates that proposed regulations will provide that the tax must be reported on IRS Form 720 (Quarterly Federal Excise Tax Return). The IRS intends to issue an additional form relating specifically to the stock buyback tax that taxpayers will attach to Form 720.
- Although Form 720 is generally filed quarterly, the stock repurchase excise tax will be reported once a taxable year on Form 720 which is due for the first full quarter after the close of the taxpayer’s taxable year. For example, a taxpayer with a taxable year ending on December 31, 2023, would report its stock repurchase excise tax on Form 720 for the first quarter of 2024, due on April 30, 2024.
- The deadline for payment of the stock repurchase excise tax is the same as the filing deadline.
- No extensions are permitted for reporting or paying the stock repurchase excise tax owed.
Which corporations are subject to the tax, and what constitutes a repurchase or “economically similar transaction”
- Only a corporation whose stock is traded on an “established securities market” is subject to the tax. An “established securities market” is broadly defined to include certain national, foreign and regional securities exchanges and brokerage systems (as defined in section 1.7704-1(b)).
- The tax applies to repurchases as defined in section 317(b) (governing stock redemptions), except for (i) a deemed redemption resulting from certain section 304 transactions (redemption through the use of a related corporation) and (ii) certain payments of cash in lieu of fractional shares.
- The following transactions are “economically similar transactions,” such that the tax applies to the extent of the corporation’s receipt of cash (boot) for its stock: (i) acquisitive reorganizations (certain A-, C-, and D-reorganizations); (ii) E-reorganizations, (iii) F-reorganizations and (iv) section 355 split-offs.
- Additionally, a distribution in liquidation governed by both section 331 and 332(a) is an “economically similar transaction” with regard to the shareholders whose treatment is governed by section 331 but not with regard to the shareholder whose treatment is governed by section 332(a). (For example, if a corporation with an 80% corporate shareholder and a 20% minority shareholder merges into its corporate parent (and section 332(a) applies) and pays cash to its minority shareholder (and section 331 applies), the minority shareholder’s exchange of its shares for cash is subject to the excise tax.)
- The following transactions are not “economically similar transactions”: (i) section 332 liquidations (with regard to the shareholder qualifying under section 332), (ii) distributions in liquidation governed by section 331 where section 332(a) does not apply to the transaction and (iii) divisive transactions under section 355 other than split-offs.
How to determine the timing and fair market value (FMV) of repurchased stock
- Stock is treated as repurchased at the time at which ownership of the stock transfers to the covered corporation for Federal income tax purposes.
- The FMV of repurchased stock is the market price of the stock on the date the stock is repurchased. Accordingly, if the repurchased stock’s purchase price differs from the stock’s market price on the repurchase date, the stock’s FMV for purposes of the excise tax is the market price and not the purchase price.
- If the repurchased stock is traded on an established securities market, the taxpayer must determine the market price of the repurchased stock by applying one of several safe harbor methods specified in the Notice.
How to apply the exception regarding a repurchase treated as a dividend and the netting rule
- A repurchase to which section 302 (governing stock redemptions) or section 356(a) (governing boot received in non-recognition transactions) applies is presumed to not constitute a dividend (and, therefore, is presumed ineligible for the dividend exception and instead subject to the excise tax) unless the corporation rebuts the presumption. A corporation may rebut the presumption with regard to a specific shareholder solely by establishing with “sufficient evidence” that the shareholder treats the repurchase as a dividend on the shareholder’s Federal income tax return. Details rules govern the meaning of “sufficient evidence.”
- Under the netting rule, the stock repurchase excise tax base is reduced by the FMV of stock the covered corporation issued or provided to employees and others during the corporation’s taxable year.
- For purposes of the netting rule, certain of the section 83 rules apply to determine the date on which stock is treated as provided to employees.
- Certain issuances are disregarded for purposes of the netting rule, including: (i) stock distributed by the corporation to its shareholders with respect to its stock, (ii) stock issued by the corporation to certain affiliates, (iii) certain issuances of stock as part of a section 368(a) or section 355 transaction, (iv) deemed stock issuances under section 304(a)(1) and (v) issuances of stock in an E-reorganization.
As noted above, these rules constitute interim guidance until regulations are issued. We recommend that taxpayers unsure how to apply these rules consult with their tax advisors.