In general
The new stock buyback excise tax generally only applies to “covered corporations” that repurchase their own shares. A “covered corporation” is typically a domestic corporation whose stock is traded on an established securities market, such as the NYSE or NASDAQ. However, the scope of this tax extends beyond just domestic corporations. The excise tax can also apply to certain foreign corporations and acquisitions of stock by certain related parties.
In addition to these general rules, there are more detailed provisions that broaden the taxpayer base for the excise tax. Two of the more relevant rules to many taxpayers are the “funding rule” and the “netting rule”. As discussed below in more detail the funding rule further expands the scope of applicability of the excise tax outside of direct repurchases. Another important detailed provision is the “netting rule”, which allows corporations to offset the buybacks against certain issuances of new shares.
Funding rule
The "funding rule" as outlined in the Proposed Regulations, is designed with a focus on transactions involving certain affiliates of certain foreign corporations. Specifically, the proposed funding rule retains the general structure of the funding rule provided in the Notice but introduces substantial modifications. Under this proposed rule, affiliates of foreign corporations are treated as acquiring stock (i.e., covered purchase) of the foreign corporation to the extent that the affiliate funds (i.e., covered funding) the repurchase or acquisition of stock, if done with a principal purpose of avoiding the stock repurchase excise tax. In summary, the funding rule treats a U.S. subsidiary of a foreign parent company as a “covered corporation” subject to the excise tax if it funds the repurchase of stock, to prevent tax avoidance through strategic funding of stock repurchases.
Example:1
Facts - Corporation FZ owns all the outstanding stock of Corporation US1, a domestic corporation. On March 1, 2024, Corporation US1 makes a distribution with respect to its stock of $600x to Corporation FZ. A principal purpose of the distribution is to fund a covered purchase. On May 15, 2026, Corporation FZ repurchases 100 shares of its stock when the fair market value of each share is $8x.
Analysis - Because a principal purpose of the distribution by Corporation US1 to Corporation FZ is to fund a covered purchase, the distribution of $600x is a covered funding. The repurchase by Corporation FZ of its stock is a repurchase and therefore a covered purchase. The entire amount of the covered purchase, or $800x, is the allocable amount of the covered purchase. The entire amount of the covered funding, or $600x, is allocated to the allocable amount of the covered purchase because the amount of the covered funding is less than the amount of the covered purchase. The amount of stock of Corporation FZ acquired in the covered purchase that is treated as acquired by Corporation US1 is equal to the amount of covered fundings allocated to the allocable amount of the covered purchase, or $600x (which represents 75 of the 100 shares of stock repurchased). Corporation US1 is treated as acquiring stock of Corporation FZ in a section repurchase on May 15, 2026. For purposes of computing Corporation US1's excise tax base, the fair market value of the 75 shares of stock of Corporation FZ subject to the repurchase is $600x. Accordingly, the repurchase by Corporation US1 increases its excise tax base for the 2026 taxable year by $600x.
The Notice included a per se rule, which deems a principal purpose to exist if the funded entity acquires or repurchases stock within two years of the funding, other than through a distribution funding. The Proposed Regulations eliminate this per se rule and instead introduce a rebuttable presumption that applies only to transactions defined as “downstream” fundings that occur within two years. This presumption applies where affiliates of a foreign corporation directly or indirectly fund a “downstream relevant entity” within two years of a stock purchase by or on behalf of that entity. This presumption can be rebutted with facts and circumstances that clearly establish that avoiding the excise tax was not a principal purpose of the funding.
The Proposed Regulations further clarify if there are multiple covered fundings and the aggregate amount of those fundings exceeds the allocable amount of the covered purchase, then covered fundings are allocated to the covered purchase in the order in which they occur, following a "first in, first out" approach. However, if multiple repurchases occur simultaneously, then the fundings would be allocated to those simultaneous repurchases on a pro rata basis.
Netting and issuance to non-employee service providers
The Proposed Regulations additionally provide clarity on the netting rule, which allows corporations to offset the value of stock issued within the taxable year against the value of stock repurchased. This includes stock issued to employees and non-employee service providers, acknowledging the broader spectrum of stock transactions beyond traditional employee compensation. It is important to note that the Proposed Regulations specify that stock provided by a specified affiliate in connection with the performance of services by a non-employee of the specified affiliate would not qualify for the netting rule.
Additional provisions
In addition to the funding and netting rules examined above, the Proposed Regulations retain many of the provisions laid out in the Notice with those modifications noted below.
Section 305 distributions
Consistent with the Notice, the Proposed Regulations provide that stock of a covered corporation distributed under section 305(a) or (b), by a covered corporation to its shareholders is disregarded for purposes of the netting rule.
Dividend exception
The dividend exception provides that the fair market value of stock repurchased by a covered corporation is eligible for a reduction in the computation of the corporation's stock repurchase excise tax base to the extent that the repurchase is properly treated as a distribution of a dividend.
The Proposed Regulations establish a rebuttable presumption of non-dividend-equivalence, which can be difficult to counter. In order to rebut the presumption, the Proposed Regulations specify a detailed process for a covered corporation to provide sufficient evidence that a shareholder treats a repurchase as a dividend on their Federal income tax return. These requirements generally include; obtaining a certification from the shareholder, treating the repurchase in a manner that is consistent with the shareholder's certification, and demonstrating that the covered corporation has sufficient earnings and profits to treat the transaction as a dividend.
Notably, the Proposed Regulations do not permit corporations to rely on filings with the Securities and Exchange Commission (SEC) (or similar filings) to determine the extent to which redemptions may be treated as qualifying for the dividend exception.
Other key provisions explained
What constitutes stock?
General definition of “stock”
Consistent with the Notice, the Proposed Regulations maintain the meaning of "stock" as any instrument issued by a corporation that is stock (including treasury stock) or that is treated as stock for federal tax purposes at the time of issuance, regardless of whether the instrument is traded on an established securities market. However, unique to the Proposed Regulations is that the term "stock" does not include preferred stock that qualifies as additional tier one capital and does not qualify as common equity tier one capital (i.e., additional tier one preferred stock).2
Instruments not in the legal form of stock
Instruments that do not take the legal form of stock but are treated as stock for federal income tax are included in the excise tax. This inclusion is part of a broader effort to ensure that the essence of what constitutes stock for tax purposes captures a wide array of financial instruments, thereby preventing entities from circumventing tax obligations through creative financial structuring.
An anti-abuse rule has been established to address potential abuses for example, the issuance of instruments like deep-in-the-money call options with the intent to evade excise tax rules. This rule stipulates that such instruments will not be recognized under the netting rule until they are repurchased. Furthermore, the value considered for tax purposes at the time of repurchase is capped at the lesser of the instrument's fair market value at the time it was issued or when it was repurchased, contingent upon the repurchase being timely reported.
Issuance and repurchase (valuation and timing)
Generally
The Proposed Regulations generally provide that the repurchase date is the trade date of the publicly traded stock. Additionally, in most cases, the issue date of stock is the date on which tax ownership of the stock transfers to the recipient for federal income tax purposes.
Settlement of options
The Proposed Regulations provide that for the physical settlement of options or derivatives, the fair market value of stock repurchased or issued upon the physical settlement of an option contract is determined as of the time of the repurchase or issuance. This determination emphasizes the importance of the actual market value as opposed to using a predetermined strike price. Notably however, the net cash settlement of options is not considered a repurchase. Taxpayers should be wary of this distinction should they repurchase stock through the year and are applying the netting rule to option issuances.
Valuation of publicly traded stock
The Proposed Regulations provide for the valuation of publicly traded stock for the purposes of the excise tax on repurchases and issuances under section 4501 by specifying commonly accepted valuation methods as appropriate means for determining the fair market value of such stock. For consistency, the Proposed Regulations mandate that taxpayers consistently apply the chosen valuation method throughout the taxpayer's taxable year.
Common relevant transactions
Complete liquidations
Consistent with the Notice, The Proposed Regulations provide that distributions in complete liquidations (under section 331 or 332, but not both) are generally not considered repurchases.
Partial liquidations
The Proposed Regulations provide that redemptive partial liquidations (constructive or actual) are generally treated as repurchases, consistent with sale or exchange treatment generally given to these partial liquidations.
304 transactions
The Proposed Regulations generally affirm the approach taken in the Notice, which exempts solely, section 304(a)(1) transactions and does not exempt section 304(a)(2) transactions from the excise tax.
Acquisitive reorganizations
Consistent with the Notice, in the case of an acquisitive reorganization where the target corporation is a covered corporation, the exchange by the target corporation shareholders of their target corporation stock pursuant to the plan of reorganization is considered a repurchase by the target corporation. However, the Proposed Regulations leave a number of items open regarding certain other reorganization transactions (not examined herein).
355 spin-offs
In line with the Notice, the Proposed Regulations specify that a distribution by a distributing corporation of stock of a controlled corporation qualifying under section 355 (that is not a split-off) is not considered a repurchase. However, the Proposed Regulations clarify that a distribution by a distributing corporation of non-qualifying property in exchange for stock of the distributing corporation is considered a repurchase.
Conclusion
The Proposed Regulations represent welcome guidance in the regulation of stock repurchases, offering a more detailed framework for taxpayers to identify their potential excise tax liabilities. Proposed regulations are not binding to taxpayers; however, corporations and their tax advisors should thoroughly understand and adapt to these regulations, ensuring that their strategies align with the forthcoming final regulations.
Taxpayers can generally continue to rely on Notice 2023-2 to the extent that it is inconsistent with the Proposed Regulations. Additionally, stakeholders have the opportunity to comment on the Proposed Regulations within 60 days from their issuance, providing a window for feedback and potential adjustments based on public and industry insights. Lastly, the Proposed Regulations are accompanied by numerous examples designed to aid taxpayers in understanding and applying the rules.
Please note that the information provided in this article is intended for general guidance and informational purposes only. Tax laws and regulations are complex and subject to change, and the application of such laws and regulations can vary widely based on the specific facts and circumstances involved. Therefore, we strongly advise consulting with a qualified tax professional or legal advisor.
