The Situation: A new nondeductible 1% excise tax imposed on certain stock repurchases (enacted as new section 4501 as part of the Inflation Reduction Act on August 12, 2022) (the “Stock Buy-back Excise Tax”) went into effect on January 1, 2023. On December 27, 2022, Treasury issued Notice 2023-2 (the “Notice”) providing interim guidance upon which taxpayers may rely until final regulations are promulgated. The statutory language is broad and may apply to a range of transactions that taxpayers may not have expected prior to the Notice’s publication.
The Result: The Notice clarifies those transactions that are subject to the Stock Buy-back Excise Tax, how the base amount for the Stock Buy-back Excise Tax (the “Excise Tax Base Amount”) is calculated, and which stock issuances reduce the Excise Tax Base Amount.
Looking Ahead: Affected corporations should review repurchases of their stock to determine whether they are subject to the Stock Buy-back Excise Tax. These corporations should also take into consideration any issuances, or other uses, of their stock that may reduce the Excise Tax Base Amount.
Corporations and Transactions Affected by the Stock Buy-back Excise Tax
In addition to covered corporations, certain affiliates of covered corporations (i.e., a 50% or more owned corporate subsidiary, or a partnership, 50% or more of whose capital interests are owned by such corporation) may also be subject to the Stock Buy-back Excise Tax. The Stock Buy-back Excise Tax may also apply to certain direct or indirect purchases of foreign corporation stock by the U.S. subsidiaries of such foreign corporations (special exemptions and reduction rules apply to these types of covered corporations). The Stock Buy-back Excise Tax applies to repurchases starting January 1, 2023, regardless of the tax year of the covered corporation. All covered corporations, whether on the calendar or fiscal tax year, must report their Stock Buy-back Excise Tax on a calendar-year basis. Covered corporations with aggregate repurchases of less than $1 million in a calendar year are not subject to the tax in that year.
Calculating the Stock Buy-back Excise Tax
The Notice clarifies that the annual Stock Buy-back Excise Tax is equal to the 1% rate, times the Excise Tax Base Amount, and such base amount is equal to the aggregate fair market value of all repurchases (generally, all redemptions and “economically similar” transactions) of the covered corporation’s stock in any single tax year, reduced by excluded repurchases and certain stock issuances.
Generally, under the Notice, all redemptions are treated as repurchases and are included in the determination of the Excise Tax Base Amount. A redemption is any acquisition of stock by the issuer of such stock in exchange for property (including money). However, the Notice lists certain redemptions that are not treated as repurchases in determining the Excise Tax Base Amount (i.e., excluded redemptions), but these repurchases, other than certain liquidating distributions, certain spinoff transactions, and certain issuances of stock in corporate reorganizations, are fairly uncommon. Specifically, redemptions in connection with certain liquidating distributions are treated as repurchases under the Notice, only to the extent such redemptions are from minority owners of covered corporations that are otherwise liquidating into their 80% or more owned corporate parent. With regard to a target corporation in certain tax-free corporate reorganizations, the shares of the target corporation surrendered in exchange for acquiring corporation shares are not treated as repurchases by the target corporation. With regard to a distributing corporation in certain “split-off” transactions under section 355, stock and securities in the distributing company redeemed from the distributing corporation shareholders in exchange for stock and securities in any controlled corporation are not treated as repurchases by the distributing corporation of its stock. Finally, redemptions of stock by the covered corporation are not treated as repurchases by the covered corporation of its stock, if those redeemed shares are contributed to an “employer-sponsored retirement plan,” employee stock ownership plan, or similar plan.
Reductions to the Excise Tax Base Amount
The Excise Tax Base Amount is reduced for certain issuances of covered corporation stock by the covered corporation. Specifically, the fair market value of covered corporation stock issued or provided to employees of the covered corporation (or certain of its subsidiaries), subject to special rules regarding the timing of the issuance and withheld amounts, reduces the Excise Tax Base Amount. Of course, the fair market value of covered corporation stock issued to unrelated persons is the most prominent of the reductions to the Excise Tax Base Amount. With regard to an acquiring corporation in certain tax-free corporate reorganizations, the shares of the acquiring corporation issued to shareholders of the target corporation are not treated as issuances that reduce the Excise Tax Base Amount, where the target corporation is also a covered corporation. If the Excise Tax Base Amount is negative after reduction for any of the above issuances, the excess reduction amount cannot be carried forward or backward to different tax years (i.e., carryovers and carrybacks of excess reductions are not permitted).
Notice 2023-2 provides a special transition rule for fiscal-year filers. Under this transition rule, a covered corporation may reduce its Excise Tax Base Amount by the fair market value of all issuances of stock during its tax year, so that issuances occurring in 2022 can offset repurchases in 2023, provided such issuances and repurchases occur in the same tax year of such covered corporation.
Determining “Fair Market Value” of Repurchased Shares
Under the Notice, the aggregate fair market value of all repurchases is determined first by identifying the specific date during a tax year that stock is acquired by the covered corporation, and then multiplying those shares by the “market price” of such shares on such date. If the stock is traded on an established securities market, the “market price” must be based on one of the following methodologies:
- The daily “VWAP” (volume-weighted average price) as determined on the date the stock is repurchased;
- The closing price on the date the stock is repurchased;
- The average of the high and low prices on the date the stock is repurchased; or
- The trading price at the time the stock is repurchased.
A covered corporation must consistently use one of the above methodologies for purposes of determining the fair market value of all repurchased and issued shares during the tax year. Thus, the actual price paid for repurchased shares may not be relevant for purposes of determining their fair market value. If the stock is not traded on an established securities market, rules under section 409A must be used to determine the market price of the stock, and if the stock is not repurchased on a trading day, the market price is determined as of the immediately preceding trading day.
Tax Forms, Deadlines, and Other Mechanics
Taxpayers report most excise tax liabilities on IRS Form 720. The IRS plans to update its Form 720 to include the Stock Buy-back Excise Tax and has issued (in draft form) an additional form, Form 7208, that covered corporations will attach to Form 720 specifically to report their Stock Buy-back Excise Taxes. Form 720 is a quarterly reporting form, but unlike most excise tax filings, the reporting of stock repurchases and the annual Stock Buy-back Excise Tax liability will only require annual filing of Form 720. The due date for this annual reporting will be the last day of the first month after the end of the first quarter of the year following the tax year being reported. For example, a covered corporation will report its stock repurchase excise tax on Form 720 for the 2023 tax year on April 30, 2024. Payments of the Stock Buy-back Excise Tax will be due with the annual Form 720 tax filing, and extensions to report and pay the Stock Buy-back Excise Tax will not be allowed.
Four Key Takeaways
- To calculate the Excise Tax Base Amount, a covered corporation must aggregate the fair market value of all repurchases (generally, all redemptions subject to the excise tax and “economically similar” transactions, and reduced by excluded repurchases) of the covered corporation’s stock in each calendar year, and the fair market value of certain stock issuances.
- Redemptions that are not repurchases include (i) liquidating redemptions from an 80% or more owned corporate parent, regardless of whether the liquidating company has minority owners, (ii) tax-free reorganizations to the extent that shares of a target corporation are exchanged for acquiring corporation shares, (iii) “split-offs” in which stock or securities of the distributing corporation are exchanged for stock or securities in the controlled corporation, and (iv) redemptions where redeemed shares are contributed to an “employer-sponsored retirement plan,” employee stock ownership plan, or similar plan.
- Certain stock issuances, including issuances to employees of the covered corporation, issuances to unrelated persons, and issuances of stock by an acquiring corporation to shareholders of a privately owned target corporation in a tax-free reorganization, reduce the Excise Tax Base Amount.
- The IRS has issued a draft tax form, Form 7208, which must be attached to the annually filed Form 720 (Quarterly Federal Excise Tax Return) to report transactions subject to the Stock Buy-back Excise Tax.