The intention of Senate Finance Committee Chair Ron Wyden was clear in advocating for the excise tax on stock repurchases: to stop “mega-corporations” from using stock buybacks to “juice their stock prices and reward their executives and wealthiest investors through massive stock buybacks”. However, the legislation as it exists today may cast a larger net than was initially intended.
Section 4501, the excise tax on the repurchase of corporate stock, was added to the Internal Revenue Code upon the passage of the Inflation Reduction Act in August of 2022. Under Section 4501, covered corporations must pay a 1% tax on the fair market value of any corporate stock that the corporation repurchases during the taxable year. Easy enough, right? However, with broad definitions coupled with an implementation date for stock repurchases occurring after December 31, 2022, many corporations are left scratching their heads as to how to best approach the new tax. It is important to highlight that nowhere in the current legislation does it provide a transition rule for transactions already underway before the enactment date of the bill. Therefore, provided the repurchase takes place after December 31, 2022, the excise tax will apply, regardless of when the plan was authorized or announced.
The good news is that the excise tax does not apply to all corporations. Although Senator Wyden focused on “mega-corporations,” the definition of a covered corporation could capture more corporations than intended. A covered corporation is a domestic corporation with stock traded on an established securities market. Based on the current language, the definition of a covered corporation could have an unexpected application to domestic-incorporated special purpose acquisition companies (“SPACs”). The redemption of public shares in connection with a business combination would be subject to the new excise tax even though the repurchases are part of the stock terms and would apply even if the redeemed shareholders do not realize any gain on the repurchases. Another application of the excise tax for SPACs could include shareholders opting to have their shares redeemed in connection with a specified charter amendment allowing for an extended investment period.
The new law states that a repurchase occurs when a corporation acquires stock from a shareholder in an exchange for property, whether the acquired stock is canceled, retired, or held as treasury stock. Therefore, a repurchase would include an exchange of cash, securities, or any other property for outstanding stock and would not involve a stock-for-stock exchange by the same corporation. However, the law provides extreme leeway to the Secretary of Treasury to apply the excise tax to a similar transaction that is economically like the repurchase described above. The ability of the Secretary to recategorize transactions could apply the excise tax to a distribution of property in complete or partial dissolution or liquidation of a covered corporation, which often occurs with SPACs if they do not accomplish a business combination within a pre-determined period.
Once it has been determined that a covered corporation repurchased its stock, the next step will be to determine the FMV of the stock. While the excise tax will be applied as a 1% tax on fair market value, guidance is needed as to when the fair market value will be measured. For a publicly traded company, one would presume it would be easier to determine the fair market value. Still, clarification on whether the opening, closing, prior trading day closing, or an average of the high and low prices needs to be clarified as it could cause large swings. The determination of fair market value for SPAC stock could be more challenging. In addition, a covered corporation whose stock is publicly traded may have some stock that is not publicly traded. There is no current guidance on measuring the fair market value of non-publicly traded stock that a publicly traded corporation redeems. Lastly, it is not uncommon for an employee-equity compensation arrangement to redeem the stock at a different price point from the public trading price. It is unclear whether the redemption or public trading price should be used for the FMV.
Some good news surrounding the amount of excise tax determined under §4501 concerning stock repurchased is that the fair market value that is taxed at 1% can be reduced by the fair market value of any stock issued by the covered corporation during the same taxable year (“netting rule”). The fair market value of stock issued during the year includes stock issued to employees of the covered corporation or a specified affiliate. However, the ability of a covered corporation to plan for this offset will be mute until further guidance is provided surrounding the fair market value determination.
Some exceptions apply to the excise tax rules even if a corporation is a covered corporation that repurchases stock. Exceptions to when a covered corporation can avoid the excise tax include:
1. The transaction is part of a tax-free reorganization under §368(a), and no gain or loss is recognized on such repurchase by the shareholder because of the reorganization
2. The stock repurchased, or an amount of stock equal to the value of the stock repurchased, is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan
3. The total value of the stock repurchase during the taxable year does not exceed $1,000,000
The impact of the §4501 excise tax remains unclear. The Joint Committee of Taxation estimates the fee would produce $74 billion or 10% of the revenue raised through the Inflation Reduction Act. However, the guidance regarding how strictly the law will be applied could significantly adjust the revenue projection. In addition, market leaders have expressed concern about the impact on the flow of capital. When an excise tax of 2% was being considered, over half of U.S. Chief Financial Officers said a 2% stock buyback tax would cause their company to buy back less of their shares. The impact of the new excise tax on the capital markets and as a federal revenue raiser is still unclear, and any developments should be monitored closely.