Editor: Alexander J. Brosseau, CPA
The Inflation Reduction Act, P.L. 117-169, was signed into law on Aug. 16, 2022. The act included a new Sec. 4501 that imposes an excise tax on certain repurchases of stock by publicly traded corporations.
In general, and before considering exceptions, the amount of the excise tax is equal to 1% of (1) the aggregate fair market value (FMV) of stock repurchased by a corporation, over (2) the aggregate FMV of stock issued by the corporation, in each case, during the tax year. The excise tax applies to repurchases of stock by corporations beginning after Dec. 31, 2022. The excise tax is not deductible for purposes of computing U.S. federal income tax (Sec. 275(a)(6)).
The Inflation Reduction Act did not include any legislative history that describes the underlying policy for the excise tax. Based on prior draft legislation proposing an identical excise tax, the apparent policy is to disincentivize publicly traded corporations from using available cash to repurchase stock (including any savings resulting from the lowering of the U.S. federal corporate income tax rate to 21%), which may increase earnings per share and benefit corporate executives who have stock based compensation as well as other shareholders (see, e.g., Press Release for Proposed Stock Buyback Accountability Act (Sept. 10, 2021); President Biden Announces the Build Back Better Framework (Oct. 28, 2021) (“[I]ncludes a 1% surcharge on corporate stock buybacks, which corporate executives too often use to enrich themselves rather than investing [in] workers and growing their businesses”)).
Sec. 4501(f) provides that the IRS will prescribe such Treasury regulations and other guidance as are necessary or appropriate to carry out, and to prevent the avoidance of, the purposes of this section, including regulations and other guidance (1) to prevent the abuse of the exceptions provided by Sec. 4501(e); (2) to address special classes of stock and preferred stock; and (3) for the application of the rules with respect to foreign corporations under Sec. 4501(d).
On Dec. 27, 2022, Treasury and the IRS released Notice 2023-2, which announced that they intend to issue proposed regulations with respect to the excise tax. The notice provides interim guidance that Treasury and the Service generally intend to include in the proposed regulations, including several examples that illustrate the application of the rules set forth in the notice. Treasury and the IRS anticipate that the proposed regulations will be consistent with the guidance provided in the notice. In addition, until the issuance of the proposed regulations, taxpayers are permitted to rely on the operating rules set forth in Section 3 of the notice. The proposed regulations are anticipated to apply to repurchases of stock made after Dec. 31, 2022, and to issuances of stock made during a tax year ending after Dec. 31, 2022.
Contrary to the apparent underlying policy for the excise tax described above, the notice contains rules that result in a broad application of the excise tax. The notice requests comments, including on aspects of the excise tax not discussed in the notice. Thus, the proposed regulations could have additional rules or rules different from those set forth in the notice.
Although the application of the excise tax to foreign corporations is beyond the scope of this item, Sec. 4501(d) generally provides that the excise tax applies to acquisitions of stock of a publicly traded foreign corporation by certain U.S. affiliates. The notice significantly expands this statutory rule, whereby the excise tax can apply where the U.S. affiliate does not acquire, but is treated as funding the acquisition of, stock of the publicly traded foreign corporation, and the principal purpose of such funding is to avoid the excise tax (including a “per se rule,” where a principal purpose is deemed to exist if stock acquisitions occur within two years of certain fundings). In addition, except as described here, compensation-related aspects of the excise tax are beyond the scope of this item.
Corporations subject to the excise tax
The excise tax applies to a “covered corporation” that repurchases its stock (Sec. 4501(a)). A covered corporation means any domestic corporation the stock of which is traded on an “established securities market” within the meaning of Sec. 7704(b)(1) (Sec. 4501(b)). Notice 2023-2 defines the term “established securities market” by reference to Regs. Sec. 1.7704-1(b), which includes, among other things, (1) a national securities exchange that is registered under the Securities Exchange Act of 1934 (e.g., NYSE and NASDAQ); and (2) an interdealer quotation system that regularly disseminates firm buy or sell quotations by identified brokers or dealers by electronic means or otherwise (which could include over-the-counter (OTC) markets).
Although covered corporation status requires a corporation’s class of stock to be traded on an established securities market, the notice provides that “stock” means any instrument issued by a corporation that is treated as stock for U.S. federal income tax purposes. Thus, repurchases of nontraded classes of stock of a covered corporation would be taken into account for purposes of the excise tax (see the notice, Section 3.09, Example 1, where the excise tax applies to a redemption by a covered corporation of mandatorily redeemable preferred stock that is not traded on an established securities market). As mentioned above, the regulatory authority set forth in Sec. 4501(f) included guidance to address preferred stock; however, the notice, as evidenced by the example, did not contain any exceptions for preferred stock, including where the covered corporation had the obligation (and not the option) to redeem the preferred stock.
In addition, Sec. 4501(c)(2) provides that purchases of covered corporation stock by a “specified affiliate” are treated as repurchases by the covered corporation. For this purpose, “specified affiliate” means (1) any corporation more than 50% of the stock of which is owned (by vote or by value), directly or indirectly, by the covered corporation; and (2) any partnership more than 50% of the capital interests or profits interests of which is held, directly or indirectly, by the covered corporation (Sec. 4501(c) (2)(B)). However, purchases of covered corporation stock by a specified affiliate from the covered corporation or another specified affiliate of such covered corporation are not treated as repurchases (Sec. 4501(c)(2)(A)).
Computation of the excise tax
Notice 2023-2 sets forth a computation for the excise tax that is consistent with the 1% computation set forth in Secs. 4501(a) and (c) but allows for the administration of the rules and constructs contained in the notice. In this regard, the notice provides that the amount of the excise tax imposed on a covered corporation is equal to 1% times the stock repurchase excise tax base. “Stock repurchase excise tax base” is defined as an amount (not less than zero) equal to the FMV of all repurchases (as defined in Section 3.04 of the notice) of the covered corporation’s stock during the tax year (as measured and determined under Section 3.06 of the notice), subject to reduction in the following order:
- FMV of any repurchases that are subject to one of the “statutory exceptions” under Sec. 4501(e); and
- The FMV of any stock issued by the covered corporation under the “netting rule” under Sec. 4501(c).
The notice provides that any excess reductions under the statutory exception and/or the netting rule may not be carried back or carried forward to other tax years.
Transactions subject to the excise tax
A “repurchase” of stock is defined as any (1) redemption within the meaning of Sec. 317(b); and (2) transaction determined by the IRS to be economically similar to a redemption of stock (“economically similar transactions”) (Sec. 4501(c)(1)(A)). Under Sec. 317(b), a redemption of stock means an acquisition by a corporation of its own stock from a shareholder in exchange for property other than the corporation’s own stock or rights to acquire such stock. Notice 2023-2 provides for two limited and exclusive exceptions with respect to Sec. 317(b) redemptions. The first exception is for the deemed redemption of acquiring corporation stock that occurs as a result of the application of Sec. 304(a)(1) to a related-party stock acquisition. The second exception is for deemed redemptions where cash is received in lieu of fractional shares (and certain conditions are met).
Thus, the notice takes a very broad definition of “repurchase” such that, other than the two exceptions above, all other transactions that are treated as redemptions under general U.S. federal income tax principles would be treated as repurchases. For example, leveraged buyout transactions would be treated as repurchases where the cash consideration received by the covered corporation shareholders is sourced from existing cash of the covered corporation or debt of a merger subsidiary that is assumed by the covered corporation (see the notice, Section 3.09, Examples 3 and 4).
The notice also includes guidance with respect to economically similar transactions, which are treated as repurchases by covered corporations. In particular, the notice sets forth the following exclusive list of transactions that Treasury and the IRS intend to treat as economically similar transactions: (1) “acquisitive reorganizations,” i.e., reorganizations described in Sec. 368(a)(1) (A) (including by reason of Sec. 368(a) (2)(D), (E), or (C), or Sec. 368(a)(1) (D) (but the latter only if the conditions in Sec. 354(b)(1) are met) (which are treated as repurchases by the target corporation of its stock from the target corporation shareholders in exchange for the reorganization consideration); (2) “recapitalizations” under Sec. 368(a)(1) (E); (3) “F reorganizations” under Sec. 368(a)(1)(F); (4) distributions qualifying under Sec. 355 (whether or not part of a reorganization under Sec. 368(a)(1)(D)) in which shareholders of the distributing corporation exchange distributing corporation stock for stock in a controlled corporation (including money and other property) (i.e., “split-offs”); and (5) a liquidation to which both Sec. 332 and Sec. 331 apply (in general, a liquidation with an 80%-plus corporate shareholder and minority shareholders).
As discussed below with respect to the statutory exclusion relating to Sec. 368(a) reorganizations, the broad definition of “repurchase” pursuant to the foregoing economically similar transactions is mitigated to some extent by effectively allowing covered corporations to offset repurchases where the consideration received by covered corporation shareholders is property that can qualify for nonrecognition treatment.
The following is a nonexclusive list of transactions that are not economically similar transactions under the notice: (1) complete liquidations where only Sec. 332 or only Sec. 331 applies (see the notice, Section 3.09, Example 16 — in addition, where Sec. 331 applies, with respect to any distributions that occur in the liquidating corporation’s final tax year); and (2) distributions of stock of a controlled corporation by a distributing corporation that qualify under Sec. 355 but are not a split-off (e.g., pro rata spin-offs — see the notice, Section 3.09, Examples 13 and 14).
Timing and FMV
Pursuant to Notice 2023-3, stock generally is treated as repurchased when its ownership transfers for U.S. federal income tax purposes to the covered corporation or the relevant specified affiliate. See, for example, the notice, Section 3.09, Example 15 — an accelerated share repurchase agreement between a covered corporation and an investment bank involved two repurchases, (1) one repurchase where, upon entering into the agreement, the investment bank borrowed covered corporation shares on the open market and delivered the shares to the covered corporation in exchange for a cash payment; and (2) a second repurchase where, upon final settlement of the agreement, the investment bank delivered additional covered corporation stock to the covered corporation.
The timing for a transfer of ownership for U.S. federal income tax purposes may not be clear, as in the case of open market purchases where the trade and settlement dates may occur several days apart. For economically similar transactions, stock is treated as repurchased when the shareholders of the covered corporation exchange their covered corporation stock (e.g., for an acquisitive reorganization, the effective date of a merger).
In addition, under the notice, the FMV of the repurchased stock is the “market price” of the stock on the date of the repurchase, regardless of the consideration actually paid for the stock. Where the repurchased stock is traded on an established securities market, the covered corporation is required to apply one of the four following “acceptable methods” for determining the market price for the date the stock is repurchased: (1) the daily volume-weighted average price; (2) the closing price; (3) the average of the high and low prices; or (4) the trading price. If the date of repurchase is not a trading day, then the covered corporation must apply the selected method to the immediately preceding trading day. Covered corporations are required to consistently use a selected method for all repurchases during the tax year (but apparently may chose a different method for another tax year).
If the repurchased stock is not traded on an established securities market, the market price is required to be determined under the principles of Regs. Sec. 1.409A-1(b)(5)(iv)(B)(1). The provision generally provides that the FMV of stock may be determined using a reasonable application of a reasonable valuation method.
As indicated above, the stock repurchase excise tax base is first reduced by the amount of any repurchases that qualify for one of several statutory exceptions.
One statutory exception relates to repurchases relating to Sec. 368(a) reorganizations (Sec. 4501(e)(1)). Under this exception, stock is not treated as repurchased to the extent that the repurchase is part of a Sec. 368(a) reorganization and no gain or loss is recognized on the repurchase by the shareholder by reason of the reorganization. As described above, these transactions (including split-offs) are treated as economically similar transactions in which the target corporation (in an acquisitive reorganization), recapitalizing corporation (in an E reorganization), transferor corporation (in an F reorganization), or distributing corporation (in a split-off), as applicable, is a covered corporation.
In these cases, the stock repurchase excise tax base is reduced to the extent that the covered corporation makes the repurchase with consideration permitted to be received under Sec. 354 or 355 without the recognition of gain or loss. Accordingly, if only qualifying consideration is received under those provisions (in general, other than “nonqualified preferred stock” within the meaning of Sec. 351(g) unless exchanged for other nonqualified preferred stock), the stock repurchase excise tax base would be zero (ignoring any other repurchases or issuances).
To the extent that one of the foregoing transactions involves cash or other property (i.e., “boot”), the stock repurchase excise tax base would be equal to the amount of such boot (see the notice, Section 3.09, Examples 6, 8, 9–14, and 19). Thus, Notice 2023-2 did not adopt the construct set forth by the Supreme Court in Clark, 489 U.S. 726 (1989), for purposes of determining dividend treatment under Sec. 356(a)(2), whereby the acquiring corporation is deemed to issue stock and then redeem the stock in exchange for any cash or other boot. Following the Clark construct would have resulted in repurchases relating to boot effectively not being subject to the excise tax because there would have been offsetting deemed issuances and redemptions.
Another statutory exception relates to a repurchase being treated as a dividend under Sec. 301(c)(1) or Sec. 356(a)(2). The notice provides that a redemption under Sec. 302 or an exchange under Sec. 356 that is treated as a repurchase is presumed not to be a dividend and therefore is ineligible for the exception. The foregoing presumption may be rebutted if the covered corporation complies with several requirements that are intended to ensure that the repurchase is a dividend and will be reported as such for U.S. federal income tax purposes (e.g., delivery of a Form 1099-DIV, Dividends and Distributions).
Adjustment to amount subject to tax-netting rule
For purposes of calculating the excise tax, Sec. 4501(c)(3) provides that the aggregate FMV of the stock repurchased by the covered corporation during the tax year is reduced by the aggregate FMV of any stock issued by the covered corporation during the tax year. For this purpose, stock issued includes stock issued or provided to employees of the covered corporation or a specified affiliate of the covered corporation.
The FMV (under Notice 2023-2, the market price) of each repurchase and issuance must be determined. Consequently, excise tax may be due even though the number of shares issued offsets (or more than offsets) the number of shares repurchased. In contrast, no excise tax may be due even though the number of shares repurchased is greater than the number of shares issued.
Consistent with Sec. 4501(c)(3), the notice provides that the stock repurchase excise tax base for a covered corporation’s tax year (after making any reductions pursuant to the statutory exceptions) is reduced by the FMV of the stock of the covered corporation that is: (1) issued or provided to employees of the covered corporation or a specified affiliate of the covered corporation; or (2) issued by the covered corporation to persons other than employees described in clause (1). Based on the foregoing, for purposes of the netting rule, the notice does not appear to include covered corporation stock transferred by a specified affiliate to persons other than employees. For example, if a specified affiliate uses covered corporation stock to make an acquisition (including an acquisitive reorganization of a noncovered corporation), such covered corporation stock does not appear to result in a reduction under the netting rule.
As is the case with respect to stock repurchases, the notice provides that stock generally will be treated as issued or provided by the covered corporation when ownership of the stock transfers for U.S. federal income tax purposes. Although beyond the scope of this discussion, the notice includes rules for purposes of determining when stock is treated as issued or provided to employees (e.g., where a Sec. 83(b) election is made by the employee to include the FMV of the stock received in gross income). Also, the notice provides that the market price rules for determining the FMV of repurchases described above also apply for purposes of determining the FMV of stock issued under the netting rule (including the requirement to consistently use the selected method for a tax year). Such rules, however, do not apply with respect to determining the FMV of stock issued or provided to employees.
In addition, the notice contains a list of stock issuances that are not taken into account under the netting rule. The list includes: (1) distributions of stock by a covered corporation with respect to its stock (e.g., stock dividends under Sec. 305 (see the notice, Section 3.09, Example 5)); and (2) stock issued by the covered corporation to a specified affiliate. The list also includes issuances where there was a related repurchase that was excluded under a statutory exception. For example, stock issued in an acquisitive reorganization, a recapitalization, an F reorganization, or a split-off is not taken into account under the netting rule to the extent the stock repurchase excise tax base was reduced under the Sec. 368(a) statutory exception (i.e., as described above, the stock issued is transferred to the shareholder of a covered corporation in a nonrecognition transaction under Sec. 354 or 355). In addition, any stock issued by a target corporation that is a covered corporation to the merging corporation in a reorganization under Sec. 368(a)(1)(A) by reason of Sec. 368(a)(2)(E) is not treated as issued for purposes of the netting rule.
Similarly, the list includes deemed issuances for which corresponding deemed redemptions were not treated as Sec. 317(b) redemptions (and thus not repurchases). Specifically, deemed issuances under Sec. 304(a)(1) and deemed issuances of a fractional share are not treated as issued for purposes of the netting rule.
Notice 2023-2 provides that the excise tax is anticipated to be reported annually on Form 720, Quarterly Federal Excise Tax Return, which will be accompanied by an additional form intended to help taxpayers compute the excise tax that they will be required to attach to Form 720 (the IRS released a draft of Form 7208, Excise Tax on Repurchase of Corporate Stock, on Dec. 28, 2022).
The notice further provides that Treasury and the IRS expect that the excise tax will be reported on the due date for the Form 720 by reference to the last day of the first full quarter following the close of the taxpayer’s tax year. The notice contains the following example: A taxpayer with a tax year ending on Dec. 31, 2023, would report its stock repurchase excise tax on the Form 720 for the first quarter of 2024, due on April 30, 2024.
Similarly, under the notice, the deadline for payment of the excise tax is expected to be the same as the filing deadline for the Form 720 (as described above). Thus, consistent with the language in Sec. 4501 relating to determining the FMV of stock repurchases and issuances during the tax year, the amount of the excise tax will be computed, reported, and paid on an annual basis. Finally, the notice provides that no extensions will be permitted for reporting or paying the excise tax.
More guidance yet to come
The excise tax is a new provision, and Notice 2023-2 contains initial guidance from Treasury and the IRS. Various issues remain, and the proposed regulations and other future guidance will need to be analyzed and taken into account by taxpayers for purposes of determining any liability for excise tax.
Alexander J. Brosseau, J.D., CPA, is a senior manager in the Tax Policy Group of Deloitte Tax LLP’s Washington National Tax office.Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP. For additional information about these items, contact Mr. Brosseau at 202-661-4532 or email@example.com.
This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.