IRS Releases Guidance on New Stock Buyback Excise Tax

On December 27, 2022, IRS and Treasury issued interim guidance (in Notice 2023-2) to assist taxpayers and their advisors in applying the rules on the new excise tax on repurchases of corporate stock. Taxpayers may rely on this guidance until proposed regulations are issued, which should be forthcoming.

The Notice provides additional clarity regarding the calculation of the tax base (what constitutes a repurchase and various exceptions), applying the rules to certain transactions and other events, and reporting requirements.

Background

The Inflation Reduction Act (P.L. 117-169), enacted last summer, added IRC Sec. 4501, which imposes a nondeductible excise tax on each covered corporation that repurchases its stock. The term “covered corporation” means any domestic corporation whose stock is traded on an established securities market (i.e., a publicly traded corporation).

The excise tax also applies to: 

1. Repurchases of a covered corporation’s stock by a specified affiliate. The term “specified affiliate” means a subsidiary corporation or partnership that is more than 50% owned by the covered corporation.
2. Repurchases of a publicly traded foreign company’s stock by a domestic specified affiliate of such corporation from a person that is not the foreign company or an affiliate.
3. Repurchases of a publicly traded covered surrogate foreign corporation’s stock by such corporation or by a specified affiliate of such corporation. The term “covered surrogate foreign corporation” means a foreign corporation that is subject to the anti-inversion provisions of IRC Sec. 7874.

The tax is equal to 1% of the fair market value (“FMV”) of the repurchased stock, with certain reductions. 

The excise tax applies to stock repurchases that occur after December 31, 2022, subject to certain transition rules.

Highlights Of Notice 2023-2

The 1% excise tax applies to the “stock repurchase excise tax base,” which is the FMV of all stock repurchases during the year, less the FMV of stock that meets a statutory exception, less the FMV of stock issued that year that meets a netting rule.

For this purpose, the definition of stock includes non-publicly traded stock (of a publicly traded corporation).

Under a de minimis exception, the excise tax does not apply if the total value of stock repurchased during the taxable year does not exceed $1 million. The de minimis exception is applied before any reductions. Thus, a corporation may owe tax on less than $1 million in stock repurchases if the aggregate amount of repurchases exceeds $1 million before reductions.

The steps in determining the excise tax base can be summarized as follows:

1. Determine the aggregate FMV of all stock repurchases during the tax year, including whether the transaction constitutes a “repurchase,” and the FMV of the repurchased stock.
2. Determine whether the de minimis exception applies. If repurchases are $1 million or less, then none of the repurchases are subject to the excise tax. If repurchases are over $1 million, then continue.
3. Determine whether the excise tax base can be reduced based on a statutory exception.
4. Determine whether the excise tax base can be further reduced based on any stock issuances (netting rule).

These steps are described in more detail below.

1. Aggregate FMV of Repurchased Stock

The term “repurchase” means a redemption under IRC Sec. 317(b) or an economically similar transaction.

The following transactions are not considered repurchases for purposes of the excise tax:

1. A deemed distribution resulting from the application of IRC Sec. 304(a)(1) (acquisition of shares of commonly controlled corporation from controlling person) (regardless of whether IRC Sec. 302(a) or (d) applies).
2. A payment of cash in lieu of a fractional share if the payment (a) is part of an IRC Sec. 368 reorganization or IRC Sec. 355 distribution, or pursuant to settlement of an option or financial instrument, (b) is not separately bargained-for consideration, (c) does not exceed the value of one share of stock, and (d) is made solely for administrative convenience.

The following “economically similar transactions” are treated as repurchases for purposes of the excise tax:

1. In an acquisitive reorganization (i.e., Type A, Type C, Type D reorganization), the exchange of target corporation stock.
2. In a recapitalization (i.e., Type E), the exchange of recapitalizing corporation stock.
3. In a Type F reorganization, the exchange of transferor corporation stock.
4. In a split-off, the exchange of distributing corporation stock for controlled corporation stock. The term “repurchase” does not include a distribution under IRC Sec. 355 that is not a split-off (i.e., spin-off or split-up).
5. Complete liquidations, but only to the extent that both IRC Secs. 331 and 332 apply to component distributions, and then only IRC Sec. 331 distributions (i.e., to minority shareholders) and not IRC Sec. 332 distributions (i.e., to controlling corporate shareholders) are treated as repurchases.

If either IRC Sec. 331 or 332 applies, then the distribution is not a repurchase. Additionally, if a corporation completely liquidates and dissolves during a taxable year (that is, has a final distribution to which IRC Sec. 331 applies that year), then no distribution during that taxable year is treated as a repurchase.

Generally, stock is treated as repurchased when ownership transfers for federal income tax (“FIT”) purposes. Stock repurchased in an economically similar transaction is treated as repurchased at the time the stock is exchanged.

The FMV of the repurchased stock is the market price of the stock on the date the stock is repurchased. The Notice contains rules to determine market price based on whether stock is publicly traded.

II.  Reduction for Stock that Meets Statutory Exception

After increasing the excise tax base for the aggregate FMV of stock repurchases during the year, the base is reduced for any transactions that meet a statutory exception.

The following statutory exceptions reduce the amount of repurchased stock for purposes of computing the excise tax base:

1. Repurchases for property permitted to be received without the recognition of gain or loss (under IRC Sec. 354 or 355) as part of an acquisitive reorganization (i.e., Type A or Type D reorganization), recapitalization (i.e., Type E reorganization), change in form (i.e., Type F reorganization), or IRC Sec. 355 split-off. This is known as the “qualifying property exception.”
2. Repurchased stock contributed by the covered corporation to an employer-sponsored retirement plan of the corporation, such as an employee stock ownership plan (“ESOP”). The Notice provides different rules for calculating amount of reduction depending on whether stock is the same or different class.
3. Repurchases by a dealer in securities, to the extent that the stock is acquired in the ordinary course of the dealer's business.
4. Repurchases by a regulated investment company (“RIC”) or a real estate investment trust (“REIT”).
5. Repurchases treated as a dividend under IRC Sec. 301(c)(1) or IRC Sec. 356(a)(2). If IRC Sec. 302 or 356(a) applies, then there is rebuttable presumption that the distribution is ineligible for the exception.

See examples and special considerations in Section IV, below.

lll.  Reduction for Stock Issuances

After the excise tax base is reduced for repurchases that are statutorily excepted, it is again reduced by the aggregate FMV of any stock issuances, including stock issued or provided to employees (of the covered corporation or a specified affiliate).

Stock is treated as issued at the time at which, for FIT purposes, ownership of the stock transfers to the recipient. For stock issued to employees, that might be when the shares substantially vest.

The following stock issuances are disregarded for purposes of the netting rule:

1. Stock distributed to shareholders with respect to its stock (i.e., stock distributed via a pro rata stock split).
2. Stock issued by a covered corporation to a specified affiliate.
3. Issuances that are part of a transaction to which the qualifying property exception applies.
4. Deemed issuances under IRC Sec. 304(a)(1) or deemed issuances of a fractional share.

The netting rule considers stock issuances during the entire taxable year, but a corporation with a taxable year that begins before January 1, 2023 and ends after December 31, 2022 may consider all stock issuances during that year, even if the issuance occurs before the effective date.

lV.  Examples and Special Considerations

Application of these rules may initially result in tax-free reorganizations being treated as repurchases. However, some or all the value of the stock exchanged may be excluded from the excise tax base to the extent that the property received in the exchange does not constitute boot.   

Example 1. Assume that Target merges into Corporation X in a Type A reorganization, where Target shareholders exchange $60 of their Target stock for Corporation X common stock, and $40 of their Target stock for $40 of cash. On the date of the merger, the FMV of Target’s stock is $100.

In this example, Target’s excise tax base is initially increased by $100, which is the FMV of the Target stock exchanged. However, since the $60 of Target stock exchanged for Corporation X common stock qualifies for non-recognition of gain under IRC Sec. 354, this exchange meets the qualifying property exception, and the excise tax base is reduced by $60 to $40. Note, Target’s excise tax base is not reduced for the $40 of Target stock exchanged for cash because the cash is not qualifying property. Also, Corporation X’s issuance of stock to Target shareholders in the merger is not treated as an issuance that would reduce Corporation X’s excise tax base because the issuance was part of a transaction to which the qualifying property exception applies.

Also, a complete liquidation may constitute a repurchase in part, depending on whether IRC Sec. 331 and/or IRC Sec. 332 apply.  

Example 2. Assume that Corporation X is owned by two shareholders, Corporation Z (which owns 80 shares) and Individual A (who owns 20 shares). Corporation X adopts a plan of complete liquidation that becomes effective on March 1, 2023. Corporation X has 100 shares of common stock outstanding. On April 1, 2023, all shareholders of Corporation X receive a liquidating distribution in full payment for their shares. At that time, Corporation X stock trades at $1 per share.

In this example, IRC Sec. 331 applies to the distribution to Individual A and IRC Sec. 332 applies to the distribution to Corporation Z. Because both IRC Secs. 331 and 332 apply, the distribution to Individual A (under IRC Sec. 331) is treated as a repurchase and Corporation X’s excise tax base is increased by $20. If IRC Sec. 332 did not apply (i.e., if Corporation X did not have a shareholder that was a controlling corporation), then none of the distributions would be repurchases for purposes of the excise tax.

Other considerations include the following:

• Acquisitive reorganizations are treated as repurchases; the term “acquisitive reorganization” does not include Type B reorganizations (stock-for-stock), but it does include triangular mergers.
• A reorganization with boot will be subject to the excise tax to the extent of boot.
• Debt-financed acquisitions and leveraged buyouts (that are partially funded by the target corporation) will be subject to the excise tax because the target is treated as redeeming its stock in exchange for the borrowed cash.
• Distributions in complete liquidation of a corporation (where only IRC Sec. 331 applies to the distributions) are not repurchases. Thus, special purpose acquisition companies (“SPACs”) that redeem shares and dissolve (instead of moving forward with a transaction) should not be subject to the excise tax. However, if a SPAC has a controlling corporate shareholder, then liquidating distributions to minority shareholders may be subject to the tax. Furthermore, non-liquidating redemptions are considered repurchases (subject to reduction for stock issuances under the netting rule).

V. Reporting Requirements

According to the Notice, forthcoming proposed regulations will likely require the stock repurchase excise tax to be reported annually on IRS Form 720, Quarterly Federal Excise Tax Return, even though the form is usually due quarterly. IRS recently issued draft Form 7208, Excise Tax on Repurchase of Corporate Stock, which taxpayers will be required to attach to the Form 720.

The form will likely be due for the first full quarter after the close of the taxable year. For example, a taxpayer with a taxable year ending on December 31, 2023, would file Form 720 by April 30, 2024, with no extensions.