The New Excise Tax On Corporate Stock Buybacks

Eric Solomon of Steptoe & Johnson LLP discusses the new excise tax on corporate stock buybacks and examines the issues that the IRS and Treasury will need to tackle before its implementation.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: excising stock buybacks.

We’re continuing our deep dives into the important tax provisions of the Inflation Reduction Act, which was signed into law by President Biden in August. We’ve previously looked at the corporate alternative minimum tax, the new IRS funding, and the green tax provisions.

Now we’re looking at the last-minute — but still influential — addition to the law: the new excise tax on stock buybacks.

Joining me now to talk more about this is Tax Notes legal reporter Chandra Wallace. Chandra, welcome to the podcast.

Chandra Wallace: Thanks, David. It’s good to be on.

David D. Stewart: Now, I understand you recently talked to someone about this. Could you tell us about your guest and what you talked about?

Chandra Wallace: Of course. I talked to Eric Solomon, a partner at Steptoe and Johnson here in Washington, and an adjunct professor of law at Georgetown. Eric has served as assistant secretary for tax policy in the Treasury Department and also as assistant chief counsel, corporate, at the IRS.

We talked first about the basics of the new law and its purpose, and then we got into some of the questions and issues that Treasury and the IRS will need to tackle in order to implement it. There’s not a lot of time to do that before it becomes effective January 1.

One reason I wanted to talk to Eric in particular about this is that he’s been at Treasury and the IRS working out the kinks of new tax laws and developing guidance. He’s also been on the private sector side helping clients navigate the unknowns of new legislation before guidance is available. I think he has a unique insight into the process moving forward.

David D. Stewart: All right. Let’s go to that interview.

Chandra Wallace: We’re here today with Eric Solomon, who has agreed to talk with us about the new 1 percent stock buyback excise tax that was enacted as part of the Inflation Reduction Act.

Eric, can you tell us a little bit first about what we know about the purpose of this new tax?

Eric Solomon: Sure. Thanks for inviting me.

Well, like many recent enactments by Congress, there’s very little or no legislative history. But we do know from public statements for several years Democrats have expressed concerns about stock buybacks.

In September 2021, Senators Sherrod Brown, D-Ohio, and Ron Wyden, D-Ore., proposed a 2 percent excise tax on buybacks. A revised version of that was included in the Build Back Better Act that was passed by the House in November 2021, but died in December 2021.

But now it is like a phoenix. It’s back again and it’s part of the Inflation Reduction Act, which was enacted in August of this year. The revenue estimate is $74 billion over 10 years, so it’s a very important pay-for? in the Inflation Reduction Act.

As I said, there’s no legislative history, so we only have some public comments from Brown and Wyden. Putting all the pieces together from their comments, if you ask me what the purpose is, it’s that corporations are buying back shares and they’re paying dollars to owners of capital. Owners of capital may be stockholders who are also managers or key executives of the company. They’re paying those dollars to owners of capital, but they’re not reinvesting the dollars in the business or paying wages to employees.

In the view of Brown and Wyden, the cash that should be used to reinvest in the business or pay more wages is being paid out to shareholders.

Furthermore, the payments are tax-advantaged because you get capital gains rates. The recipient of the payment generally is going to get capital gain with basis offset. And unlike dividends, there’s no withholding on payments to foreigners.

Finally, I think part of the objection is that by doing a buyback of shares, you’re reducing the number of shares outstanding. That boosts earnings per share, which boosts stock price.

For all those reasons, I think Brown and Wyden thought that there should be discouragement of stock buybacks and that’s why we have the 1 percent buyback tax that’s included in the Inflation Reduction Act.

Chandra Wallace: Who do you think will be paying this excise tax? How does this new tax work and who do you think will be subject to it?

Eric Solomon: Well, it’s very interesting that you say that, because it’s not an excise tax on the shareholders, it’s an excise tax on the corporation. The corporation is going to have to take this into account in its cost-benefit analysis when it considers doing a buyback.

Many companies have standard, continuously running buyback programs, and the question is: Is it going to influence that behavior? Is it going to cause companies to reconsider their buyback programs or is it going to be a speed bump? It’s going to raise the cost of doing the buyback programs and we’re just going to have to wait and see.

But the basic explanation of it is an excise tax imposed on the corporation. It’s in the excise tax sections of the code, and just to quote from the statute, “It’s a tax on each covered corporation,” which is a defined term, “equal to 1 percent of the fair market value of any stock of the corporation which is repurchased by the corporation during the taxable year.” We have some important concepts, and like reading any statute, we’ve got to figure out what the key words are.

Then there are the questions about fair market value. There could be some questions about how you determine fair market value when you measure it. But let’s just talk about the definitions of a covered corporation and what’s a repurchase. Well, a covered corporation is a domestic corporation, the stock of which is traded on an established securities market. There’s a cross-reference to section 7704(b).

I think even more interesting is what’s a repurchase. A repurchase is defined in the statute as “a redemption within the meaning of section 317(b) or any transaction determined by the secretary to be economically similar to a redemption.” Now that latter clause, I don’t know what it means.

Chandra Wallace: With no gloss on what “economically similar” means.

Eric Solomon: Exactly right.

Chandra Wallace: It’s an addition to the 317(b). But other than that, we don’t have any explanation.

Eric Solomon: We don’t have any explanation. My only hope with respect to that is if this can be left to Treasury, because Treasury’s going to have regulatory authority to figure out a transaction determined by the secretary to be “economically similar.”

I just hope, if they do figure out that some transaction is economically similar, that whatever guidance they put out that says that is going to be prospective. Except maybe in the case of gross abuse, maybe they’ll be retroactive.

But I would hope that any time that Treasury says, “Oh, this is economically similar to a redemption,” that’s not going to apply to a past transaction.

Chandra Wallace: I feel like with this level of uncertainty, having retrospective effect would be really unpleasant.

Eric Solomon: As the issues are identified, and as this develops, perhaps the secretary will identify some transactions they think are equivalent. But we’ll need to wait and see.

But then it says it’s a redemption within the meaning of 317(b), and 317(b) says, “Stock shall be treated as redeemed if the corporation acquires its stock from a shareholder in exchange for property.”

Property is pretty much anything except for stock from a corporation. It doesn’t just include stock in the corporation or rights to acquire the stock of the corporation making the payment to the shareholder. The definition of property is pretty broad.

Now, the effective date of the excise tax on repurchases is after December 31, 2022. One question everybody’s been asking, “Are corporations going to accelerate their repurchases?” Again, I think it all goes to the effect that companies think this is going to have. Perhaps some companies will accelerate their repurchases into 2022. The excise tax is nondeductible.

Chandra Wallace: We looked at the revenue estimates by year. It’s $74 billion over 10 years, but for the first year it was, I want to say, between $5 billion and $6 billion. It’s up a little higher for the next two years. Then for the remaining years over $8 billion per year.

I was thinking that they were baking in an expectation that repurchases would be accelerated, and so in 2023 they wouldn’t see as many.

Eric Solomon: Yeah. I think that’s an excellent theory. At some point, if we get the Joint Committee on Taxation revenue estimators in front of us, we might ask them. Generally they don’t talk about how they’ve derived their estimates, but maybe they might say why they thought that amount in the first year. But to me that’s a very logical theory.

In terms of Treasury’s authority, Treasury can bring into the term “redemption” something determined by the secretary to be economically similar to a redemption.

Treasury also has regulatory authority to provide regulations and other guidance necessary to carry out the provision and to prevent avoidance of it. We can expect that Treasury’s going to exercise its authority at some point in order to try to explain some of the ambiguous aspects of it.

One of the things I find particularly interesting is that regulatory authority is given to address special classes of stock and preferred stock. Some people have argued that buying back preferred stock shouldn’t be covered by this, especially preferred stock that’s mandatorily redeemable, which is like debt.

Chandra Wallace: Because that’s not a decision that the corporation is making today. It’s not one that’s going to be influenced by a stock buyback tax.

Eric Solomon: You make an excellent point there that perhaps mandatory redeemable preferred stock really shouldn’t be within the scope of this. Treasury has regulatory authority to consider that issue.

But what I find interesting about that is, if I look at the statute right now, I’d say it’s covered.

Chandra Wallace: There’s no guidance yet. We have a broad definition of what’s covered. This would definitely, I think, fall within that definition without any other guidance coming from Treasury.

In the meantime, until some guidance comes out, corporations have to assume that those mandatory preferred redemptions are going to be covered by the excise tax.

Eric Solomon: I would agree with you on that.

Before we got started here, we were talking about what IRS and Treasury might be doing right now. They’re collecting issues, both for this and the corporate alternative minimum tax (AMT).

Right now, as fast as they can, they are trying to make lists of issues and figure out what they need to answer before the effective date. The effective date for both the book AMT and for this is 2023.

Now I would say, with respect to the book AMT, for 150 or 200 companies, it’s not going to be optional. There are going to be issues that need to be resolved, that Treasury and IRS need to give some guidance right away. There’s scuttlebutt that perhaps Treasury and IRS will issue a notice or two before 2023.

For the buyback tax, the question is, “OK, you collect a list of issues, what’s urgent? Among the many issues that we might spend hours discussing, are there any that are urgent that taxpayers need to know before 2023?”

I would expect if there are, then presumably IRS and Treasury would issue a notice that just says, “Here’s our view of this particular issue and we intend to include an answer to that question, and here’s the answer in regulations that we will prescribe.”

Because eventually for both the book AMT and for this, they’re going to presumably put out proposed regulations, get comments on, and final regulations. But that takes time.

In order to get answers out in a timely manner, they may pick some issues that they think are urgent and put out a notice with respect to that.

Chandra Wallace: When we talked about this earlier, you pointed out that there’s not unlimited staff at Treasury. There’s not an unlimited pool of attorneys that are going to be able to look at these things, and they’re going to have to be looking at the corporate AMT and this stock buyback tax at the same time, in addition to the other issues already on their plates.

Do you see anything in this stock buyback tax that is most likely to be a candidate for a notice sooner than 2023?

Eric Solomon: I would think that, contrasting this with the book AMT, book AMT for the 150 or 200 corporations that are going to be subject to it, they got to have some answers. There are going to be some basic questions that Treasury and IRS are going to have to answer.

For this, generally buybacks are optional. You and I discussed a couple of situations, for example, mandatory redeemable. Let’s say something’s mandatorily redeemable in January. Or let’s say a buyback has already been decided and publicly announced that it’s going to happen early in 2023. That might present situations where people need guidance right away.

But I would think that the number of emergencies for the buyback tax might be fewer than there are for the book AMT. They will be identified as taxpayers and the representatives come forward and identify the issues.

Chandra Wallace: One other outstanding issue is that there’s not really a path. There’s not a reporting process — as far as I know — for this. I know for other excise taxes, there’s usually a quarterly reporting, there’s a form for it, all those kinds of things, and a process in place. But for this, that’s another thing that IRS and Treasury are going to have to come up with. Is that right?

Eric Solomon: That’s exactly right. The IRS has an office that does forms.

I have to give a shout-out to them because when I was in the government and dealing with them, their understanding of the law and how to convert very complicated law into a form, always impressed me. I think that’s what’s going to happen here. That office is going to be brought in to create a form.

What I would expect is that it’s going to be an annual return. It’s not going to be a quarterly return. Because the way some of these rules work, for example, if you do a buyback, the amount subject to the excise tax is reduced to the extent you issue shares within the same taxable year. There are some rules that reduce the amount that you’re going to owe because you issue shares in the same taxable year. It seems it can’t be done on a quarterly report. It has to be done on an annual report.

Chandra Wallace: Right. It would be messy to try to do it on a quarterly basis.

For other kinds of excise taxes, it makes sense. The cash flows are usually always going in one direction, and so you’re going to have less of a chance of needing an offset or a cleanup at the end of the year.

Whereas here, almost all of the decisions to be made are done on an annual basis.

Eric Solomon: There is one exception that seems to apply even if the offsetting action occurs in another tax year. The excise tax does not apply in any case in which the stock repurchase, or an amount of stock equal to the value of the stock repurchased, is contributed to an employer-sponsored retirement plan or similar plan. That exception seems to go beyond the end of the taxable year.

I wonder how that would work. If you can get an offset even if the stuff is put into the retirement plan after the end of the year, how would that work administratively? I would think that Treasury might consider a rule that would cut off how long you could use the offset. That is to say, perhaps they would write a rule that says that what they offset here for stock put in a retirement plan has to occur in the same taxable year.

Chandra Wallace: Could you go back to transactions that already occurred or had already been baked in but didn’t actually pull the trigger in that same taxable year?

Eric Solomon: That’s a good point because there is no limitation. We’ve just been assuming that it’ll be put in the retirement plan afterwards, but you’re absolutely right, it could occur before.

Another possibility is you do an annual return and then you amend the annual return if you later put stock into a retirement plan. Maybe what you do is have an annual return, and then three years later if you put something into a retirement plan, you get to go backwards and amend. All these questions need to be answered.

But I would speculate there’d be an annual return, not a quarterly return. Because generally we use a taxable year and also because you can get it offset for things that might occur within the taxable year.

Chandra Wallace: We raised one of the exceptions, but there are a number of exceptions to the application of this tax. Do you want to run through what those are?

Eric Solomon: The first exception is “the amount repurchased is reduced by the fair market value of any stock issued by the corporation during the taxable year.” It includes stock provided to employees during the taxable year, whether or not such stock is issued or provided in response to the exercise of an option to purchase such stock. People are calling this the netting rule.

But what I was scratching my head about was, OK, so you get to reduce it by stock issued to employees. Is that fully vested? What if it’s subject to restrictions? Does that count? What if the shareholder has made an 83b election? Does that count?

All the issues around compensation confuse me about that. Whether or not stock that’s issued to employees that has a compensation taint to it is somehow included as stock issued to employees, I don’t know. That presumably needs clarification.

The second exception is the reorganization exception. One question just leads to another question with respect to the reorganization exception. It applies if the repurchase is part of a 368 reorganization and no gain or loss is recognized on such repurchase by the shareholder.

That raises a whole host of issues about reorganizations. Let’s say there’s boot in a reorganization. In the first question I ask, it says “a repurchase by the shareholder.” Does that mean this exception applies on a shareholder-by-shareholder basis? I’ll just leave it at that, because it gets very complicated.

Chandra Wallace: How is the corporation going to know, shareholder by shareholder, what’s going on in each of their financial lives that’s going to affect how these things are treated?

Eric Solomon: You’re exactly right. Let’s say a boot in a reorganization and you’re a shareholder and you get $5 of boot.

Chandra Wallace: And boot, in regular nontax world, is cash.

Eric Solomon: That’s exactly right. You’re a shareholder and this says that the excise tax doesn’t apply if there’s no gain gain or loss recognized by you.

Well, section 356 has a special rule that says if you don’t have gain in your shares, then even if you get cash, you don’t recognize it. Or what happens if you have a high basis in those shares and you have a loss and you get cash? Well, you’re not going to recognize gain or loss. Does the corporation somehow get to say, “Oh, you know, you didn’t have gain or loss and therefore the excise tax doesn’t apply to buyback from you?”

Chandra Wallace: They have to show up with a clipboard at your office and get the information from you.

Do you think it’s likely that Treasury and the IRS, when they’re doing guidance, will allow corporations to make certain assumptions?

Eric Solomon: They may be able to make certain assumptions, but I’m suspecting that Treasury will have to tell companies that there are going to be certain presumptions. That if there’s boot, it’ll just be presumed that the shareholders recognize gain or loss unless they prove otherwise. I don’t know how else it’ll be done.

Chandra Wallace: The other question on this would be the extent to which boot affects whether there is gain or loss. I think I’m not probably saying this right, but the extent to which boot affects the transaction.

Eric Solomon: If you have boot and gain or loss is recognized, think of the construct of a reorganization. The way the code works is, in a reorganization, the target company is — let’s say it’s a merger — is deemed to transfer its assets to the acquiring corporation in exchange for acquiring corporation stock, which then is paid out to the target shareholders in exchange for their target stock.

Well, that’s a redemption. It’s not using stock of the redeeming corporation. It’s using stock of the other corporation. If there’s boot, one might be afraid if there’s a dollar of boot and gain is recognized that it’s treated as redemption in the full amount that’s paid out to the shareholders, including both stock and cash is a redemption. It’s cash plus other property and that other property is the stock of the acquiring corporation.

I don’t expect that should be the case. It would seem to me that the right answer is that to the extent cash is paid out, that should be the full extent of the redemption.

But I’m just suggesting, under the construct that the code uses, it’s as if the target corporation is using acquiring stock to buy back the shares, which is property and therefore it could be a redemption. But there I’m expecting there should be a successor notion that the acquiring corporation stock should be equivalent to stock of the target corporation, but that the Treasury will have to write regulations.

In addition, there’s the Commissioner v. Clark case. In the Commissioner v. Clark case, for purposes of determining whether a target shareholder has a dividend or capital gain, it’s treated as if they got shares of the acquiring corporation and those were redeemed.

Does that put a whole different model on the treatment of boot in a reorganization? Do you treat it as if it’s being redeemed by the acquiring corporation? Not that it’s being redeemed by the target corporation under our first model, but it’s really being redeemed by the acquiring corporation, and therefore that’s how you would analyze this.

But if you analyze it that way, well then you may say, if you get boot, there is no redemption because under the model of Commissioner v. Clark it’s as if the acquiring corporation issued shares which were bought back. Therefore you might fall in the netting exception.

Chandra Wallace: Then you’ve offset what you might be taxed on. That’s a whole different kettle of fish.

Eric Solomon: Exactly. That’s just a simple merger with boot. We have not even peeled off all the layers of that onion.

Another exception is the de minimis exception if the buyback is less than $1 million in a year.

Then there’s an exception for buybacks by a dealer in securities, an exception for Ricks v. Reed.

The final one I wanted to get to is the excise tax does not apply to the extent that repurchase is treated as a dividend.

That goes back to a point you made. How’s a corporation supposed to know on a shareholder-by-shareholder basis whether or not it’s a dividend? Section 302 has various rules about determining whether a redemption is a dividend or not. But that’s for the shareholders to figure out. But the corporation is supposed to know in order to decide whether it is subject to the excise tax?

Chandra Wallace: One of the other things that we talked about as we were preparing was some fact patterns. We’ve talked theoretically about the questions, but what are specific fact patterns where taxpayers are going to have to navigate this new tax and figure out how these different things are going to be treated?

Eric Solomon: Well, it’s interesting. It goes to the definition of what a redemption is.

A redemption is defined in section 317(b) as “corporation buys back shares for property.” Which does not include giving out stock of the corporation exchange for the shareholder stock.

There are various simple fact patterns that we could go through and scratch our heads about. Some of them it seems kind of obvious that they would be covered. Others, it’s not so clear.

The first example is named after a case called Zenz v. Quinlivan, where a shareholder had some shares bought back and sold the rest of its shares. I own 100 shares, I want to dispose of my shares. I have the corporation buy back 40 of them and I sell the other 60 of them to a third party. Presumably the buyback of the 40 shares by the corporation, that’s a redemption.

Under the Zenz v. Quinlivan case, that’s a capital gain transaction. Presumably that’s picked up. Corporation buys back some shares, the shareholder sells the remaining shares, the buyback’s presumably subject to it. A simple Zenz v. Quinlivan transaction would be covered.

Another example is a leveraged acquisition. Many acquisitions of target corporations are done both supplying cash by the acquiring corporation, but at the same time pushing leverage into the target corporation. Essentially the assets of the target corporation support debt that is used to do part of the acquisition.

Those are leveraged acquisitions and the leverage is stuffed into the target corporation. Thus the cash of the target corporation, through some sort of borrowing perhaps, is used to buy back some of the shares and the remainder of the shares is financing by the purchasing entity or individual.

It seems to me that any leveraged acquisition where the debt is shoved into the target corporation is a redemption.

Chandra Wallace: Because form matters, and where the debt ends up is important.

Eric Solomon: Exactly right.

It kind of makes sense, if the assets of the target corporation support the acquisition of the shares, that the tax law and various authorities in the tax law say that’s a redemption. Those leveraged acquisitions, I would think, are subject to this tax.

But what do you do about it? You’re a corporation; you’re a target; you’re thinking of different planning techniques. What you do is you figure out some structure for the transaction, put the debt somewhere else. You want to put the debt as close to the assets as possible.

You might be able to structure the transaction in a way where the debt isn’t exactly in the corporation where the assets are, but you put it close by, so creditors still have a priority position. Maybe you put the debt in a tier above where the corporation whose stock is being acquired.

There may be ways to structure around it. But in every leveraged acquisition now you’re going to have to worry about whether there’s going to be this and whether you can structure around it in such a way.

Just a couple of others. There’s been a lot of talk in the press about special purpose acquisition companies (SPACs) and how various SPACs are having trouble finding target corporations at this time.

Generally, if a SPAC can’t find a target corporation, it liquidates. It’s got to return the money to the shareholders.

Chandra Wallace: But now they might have to return it minus 1 percent.

Even though this isn’t a voluntary thing, they’re not liquidating because they’ve chosen to, or they’re trying to juice the stock price, they’re just liquidating because that’s baked in.

We don’t have a target so we give the shareholders their money back.

Eric Solomon: Exactly right. A liquidation might follow the definition of redemption because it’s buying back shares for cash. Could a SPAC compelled liquidation be subject to this?

Finally, another one is a partial liquidation. Partial liquidations don’t occur that often, but those can be capital gain transactions to individual shareholders where basically a corporation sells a big portion of its assets and distributes the cash. The corporation stays alive, but it distributes the cash from the sale of one of two businesses, for example, and distributes the cash to the shareholders. That could be a capital gain transaction under section 302. Presumably that’s a redemption and therefore might be subject to the 1 percent exercise tax.

In this conversation you and I are having, we are just scratching the surface.

Chandra Wallace: There’s so many questions.

What about a split-off under section 355? If it’s not a D reorganization and it doesn’t fall into the 368 exception for reorganizations, then that’s going to fall under this excise tax, too, right?

Eric Solomon: It sort of seems that way, because in a split-off, the distributing corporation is sending shares of a different corporation, a subsidiary, out to certain shareholders who are trading in their shares of the parent corporation.

The shareholders are trading in shares of the parent corporation for stock of a subsidiary in a split-off. That seems like a redemption to me because the stock of the subsidiary is property, because it’s not stock of the distributing corporation. Could it be subject to it?

If you turn it into a D355, does that get you out of the excise tax? I wondered whether the D is just the drop and the 355 in which they trade in their shares is separate, and therefore perhaps if I make it into a D355, maybe somehow it doesn’t get the exception for a tax-free transaction because the reorganization is only the drop.

Chandra Wallace: It’s going to be fun to see what they come up with, that’s for sure. Are you glad that you don’t have to scratch your head over this and actually put out the answers?

Eric Solomon: We may have clients who want to know.

The question is, will we be able to answer the questions without guidance? We look forward to seeing what Treasury’s going to do in the short term and what the proposed regulation’s eventually going to say and how quickly they can get it done.

But I would just suggest that, like the Trump administration, getting guidance out on the Tax Cuts and Jobs Act was their highest priority and very important administration achievement. I would suggest the same thing for the Biden administration, that it’s going to be very important for them to get out guidance with regard to the Inflation Reduction Act. Because it helps implement what is, I think in the Biden administration’s view, a very important achievement of the administration.

Chandra Wallace: Well, thank you very much for agreeing to talk with us about this, for giving us all of your wisdom. I’m very grateful.

Eric Solomon: Well, thank you for having me.