Stock buyback tax: IRS issues initial guidance

Executive summary

The IRS issued Notice 2023-2 (the Notice) to address the 1% excise tax on public company stock repurchases (the stock buyback tax). The Notice:

• Specifies the types of transactions that are repurchases that can trigger the stock buyback tax,
• Describes transactions that are excepted from the stock buyback tax, and
• Outlines rules for determining the fair market value (FMV) of repurchased stock.

The Treasury Department and the IRS intend to issue proposed regulations covering these topics; taxpayers may rely on the Notice until those proposed regulations are issued.

Stock buyback tax background

The stock buyback tax was enacted in 2022 (as part of the Inflation Reduction Act of 2022). It applies only to buybacks that take place after Dec. 31, 2022. It is a nondeductible corporate-level excise tax imposed at 1% of the repurchased stock’s FMV. Under a netting rule, the total FMV of a corporation’s repurchased stock each year is reduced by the FMV of the stock it issued during the year before multiplying by the 1% tax rate.

The stock buyback tax applies to domestic corporations whose stock is traded on an established securities market. It may also apply to U.S. affiliates of a foreign corporation whose stock is traded.

Exceptions

While “repurchases” triggering the stock buyback tax are defined broadly, there are exceptions in the tax code. The Notice elaborates on these exceptions from the stock buyback tax:

• De minimis exception: This exception applies where the total amount of repurchases within the taxable year does not exceed $1 million.
• Tax-free reorganization exception: This exception applies where the repurchase is tax-free under the section 368(a) corporate reorganization rules. In this regard, the Notice clarifies the exception’s applicability to only the consideration qualifying for tax-fee treatment, and not to other “boot” consideration.
• Retirement plan/ESOP exception: This exception applies if the repurchased stock, or an equivalent value of stock, is contributed to an employer-sponsored retirement plan or employee stock ownership plan (ESOP). The Notice generally applies this exception on an average stock price basis. However, if the stock contributed and the stock repurchased are of different classes, then a date of contribution FMV method applies.
• Securities dealer exception: This exception applies if the repurchase is by a dealer in securities in the ordinary course of business. The Notice provides requirements for this exception.
• Exception for RICs and REITs: This exception applies to repurchases by a regulated investment company (RIC) or a real estate investment trust (REIT).
• Dividend exception: This exception applies to the extent the repurchase is treated as a dividend for federal income tax purposes (rather than as a sale or exchange). The Notice provides a taxpayer-unfavorable rebuttable presumption that a repurchase is not treated as a dividend. To rebut this presumption, a corporation would need to meet evidentiary requirements that may require information reporting (i.e., Forms 1099), shareholder certifications, and earnings and profits computations.

The Notice also sets out rules regarding whether and how the stock buyback tax applies to certain other transaction categories including stock compensation arrangements and liquidations. For example, the Notice excepts a corporate liquidation from the stock buyback tax only if it is a complete liquidation that qualifies in its entirety under either section 331 or section 332 of the tax code.

U.S. subsidiaries of foreign publicly traded corporations

The stock buyback tax may apply to a U.S. affiliate of a foreign corporation that has traded stock, as noted above. For example, if a U.S. subsidiary acquires stock of its foreign parent corporation and the parent’s stock is traded, stock buyback tax liability may arise for the U.S. subsidiary.

Under a funding rule, a stock repurchase made by the foreign parent corporation could also trigger the stock buyback tax if it is funded by the U.S. subsidiary. Any funding by the U.S. subsidiary undertaken for a principal purpose of avoiding the stock repurchase excise tax could trigger the tax. Additionally, the Notice deems a principal purpose of avoidance to exist if the U.S. subsidiary funds the foreign corporation in any way other than by distributions, and the foreign corporation acquires or repurchases stock within two years of the funding.

FMV of repurchased stock

Corporations subject to the stock buyback tax must measure the FMV of the stock they repurchase since the tax is based on the FMV of the repurchased stock. The Notice sets out some stock FMV rules.

For purposes of the stock buyback tax, the FMV of repurchased stock is the stock’s market price on the repurchase date. That is, if the price at which the repurchased stock is purchased differs from the stock’s market price on the date the stock is repurchased, the stock’s FMV is the market price on the date the stock is repurchased. Acceptable methods for determining the market price of traded stock include consistently applied methods based on daily volume-weighted average price, closing price, average of high and low prices, or trading price at the time of the repurchase.

For repurchased stock of a class that is not traded, the market price of the stock is a value determined by the reasonable application of a reasonable valuation method (under the valuation principles set out in the section 409A regulations for deferred compensation).

Reporting and paying the tax

The Notice sets out what the IRS expects its rules will say about reporting and paying the stock buyback tax. Here is a summary of those anticipated rules, which the IRS will release subsequently. The stock buyback tax will be reported on Form 720 (Quarterly Federal Excise Tax Return). The tax will be reported and payable once per taxable year with the Form 720 due for the first full quarter after the close of the taxable year. For example, stock buyback tax for a year ending Dec. 31, 2023, would be reported with Form 720 for the first quarter of 2024, due April 30, 2024, and payable on that date. There will be no procedure for requesting extensions. The Form 720 will be accompanied by an additional form the IRS anticipates issuing in the future.

Learn more

To learn more about how the buyback tax may affect you, please contact your Baker Tilly advisor.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.