Inflation Reduction Act Imposes New Tax on Corporate Stock Repurchases
The Situation: On August 16, 2022, the Inflation Reduction Act of 2022 (the "Act") was signed into law, enacting a new nondeductible 1% excise tax on certain share repurchases (so-called "stock buybacks").
The Result: U.S. (and in certain instances, non-U.S.) corporations, whose stock is traded on an established securities market, that undertake share repurchases of more than $1 million in the aggregate per tax year, will be subject to a 1% share excise tax on the value of any share repurchase unless such share repurchase is taxed as a dividend (other exceptions and exclusions may apply).
Looking Ahead: Companies whose shares are traded on established securities markets (e.g., the NYSE, Nasdaq, and similar markets) will need to closely monitor their share repurchases and issuances to determine if a share repurchase is subject to the new 1% share repurchase excise tax.
Which Corporations are Subject to the 1% Share Repurchase Excise Tax?
New Code Section 4501 imposes a 1% share repurchase excise tax primarily on domestic corporations, the shares of which are traded on an established securities market, and certain domestic subsidiaries that purchase the stock of their non-U.S. corporate parents, the shares of which are traded on an established securities market. Special rules apply to any repurchases of stock in a "surrogate foreign corporation" within the meaning of Code Section 7874 (the anti-inversion rule).
For purposes of this new 1% share repurchase excise tax, shares of a corporation are treated as traded on an established securities market, not only if such shares are traded on well-known markets such as the NYSE and Nasdaq, but also non-U.S. security exchanges that satisfy regulatory requirements that are analogous to the regulatory requirements under the Securities Exchange Act of 1934, such as the London Stock Exchange and the Tokyo Stock Exchange, to name a few. In addition, certain regional or local exchanges, and even interdealer quotation systems that regularly disseminate firm buy or sell quotations by identified brokers or dealers by electronic means or otherwise, are included as established securities markets under this new rule.
The 1% excise tax applies to share repurchases after December 31, 2022.
Exceptions and Exclusions
The 1% share repurchase excise tax generally does not apply to:
- Repurchases of stock that are taxed as dividends (note that corporate law characterization or terminology is not relevant in this determination);
- Repurchases in connection with tax-free reorganizations, such as certain mergers, to the extent no gain or loss is recognized by the shareholder "by reason of" the reorganization (although it is unclear how or if this exclusion applies if stock and cash are issued to target shareholders as part of the tax-free reorganization);
- Repurchases of stock, which are contributed to employee-sponsored retirement plans, employee stock ownership plans, or similar plans;
- Repurchases by RICs or REITs;
- Annual repurchases that total less than $1 million in aggregate value (after allowable reduction); and
- Certain repurchases by a dealer in the ordinary course of business.
Calculation of the Base Amount Subject to the 1% Share Repurchase Excise Tax
The amount subject to this 1% share repurchase excise tax is generally the amount paid by the issuing corporation during the year to its shareholders in exchange for their issuing corporation stock, reduced by the value of any stock issued by such corporation during the same year, including compensatory stock issuances. Thus, if a corporation repurchased its stock during any particular year in the amount of $120 million, and issued its stock for cash or compensatory purposes in the amount of $20 million during that same year, the 1% share repurchase excise tax base amount would be $100 million, and the 1% share repurchase excise tax would be $1 million.
- If applicable, the 1% share repurchase excise tax increases the cost for corporations to engage in stock repurchases, including (i) routine open market purchases, (ii) privately negotiated purchases, and (iii) purchases in registered self-tender offers. It is expected that this additional cost will reduce the prevalence of stock repurchases as a way corporations return their excess cash to their shareholders.
- This 1% share repurchase excise tax likely applies to (i) "leveraged buy-out" acquisitions of applicable target corporations, which generally result in corporations borrowing money and redeeming a significant amount of stock in connection therewith, and (ii) retirement of whole classes of preferred stock upon their maturity, if issued by a corporation whose common shares (or any other class of stock issued by such corporation) are traded on an established securities market.
- It is not clear if this excise tax will apply to a tax-free split-off, which is technically a "redemption" (or stock repurchase) under the Code.
The IRS has broad authority to subject "economically similar" transactions to the 1% share repurchase excise tax, which could mean that not only stock redemptions, but the redemption of other types of securities, will be subject to this new excise tax. We will be carefully monitoring the U.S. Treasury Department to see how it will implement this new tax.
Three Key Takeaways
- New Code Section 4501 imposes a 1% share repurchase excise tax primarily on domestic corporations, the shares of which are traded on an established securities market, and certain domestic subsidiaries that purchase the stock of their non-U.S. corporate parents, the shares of which are traded on an established securities market.
- The requirement that a corporation's shares trade on an "established securities exchange" is broader than merely trading on a well-known stock exchange, such as the NYSE or Nasdaq.
- Because stock issued by corporations during a year may affect the base amount of the 1% share repurchase excise tax, those companies subject to this excise tax will have to determine, on an annual basis, the value of their stock issuances and stock repurchases.
Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our “Contact Us” form, which can be found on our website at www.jonesday.com. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.