Stock buybacks have long been a preferred method for corporations to return excess capital to shareholders. While economically similar to a dividend, buybacks can be more targeted and have the effect of reducing the number of shares outstanding, which in turn generally increases the stock’s trading price.
In recent years, corporate stock buybacks have been the subject of controversy due to their favorable tax treatment. The shareholder in a stock buyback typically receives capital gain treatment (often long-term) and is able to recover their stock basis in the calculation of the gain or loss on the sale.
To discourage stock buybacks, the Build Back Better Act included an excise tax on the repurchase of corporate stock. The excise tax was removed from earlier iterations of the reconciliation legislation but was resurrected in the final version of the Inflation Reduction Act (IRA or “the Act”) as a revenue-raising substitute for changes to the rules regarding the taxation of carried interest.
The IRA creates a new code section 4501, which imposes a 1% excise tax on the fair value of stock repurchased by a covered corporation after December 31, 2022. The Act also provides that this excise tax is non-deductible for federal income tax purposes.
A covered corporation is a domestic corporation with publicly traded stock. The Act also provides that a repurchase by a specified affiliate of the public corporation is also subject to the excise tax. A specified affiliate is a corporation or partnership more than 50% owned (directly or indirectly) by the public corporation whose stock is being repurchased. Additionally, the IRA includes provisions to apply the tax to repurchases by a domestic subsidiary of the stock of its publicly traded foreign parent. There are also rules to apply the tax to repurchases of stock by expatriated entities or their affiliates.
The Act includes various adjustments and exclusions. The fair value of repurchased stock subject to the tax is generally reduced by the fair value of stock issued during the year. This includes the value of stock issued to employees whether in the form of stock grants or for the exercise of stock options. Excluded from the tax are repurchases that:
- Are part of a §368(a) reorganization and no gain or loss is recognized on such repurchase by shareholder
- Are contributed to an ESOP or other retirement plan
- Total less than $1,000,000 in value over the course of the tax year
- Are made by a securities dealer in the ordinary course of business
- Are made by a regulated investment company or REIT
- Are treated as a dividend
Accounting Considerations
The financial statement accounting for the excise tax on stock repurchases is subject to interpretation. Accounting Standards Codification (ASC) 740, Income Taxes, only applies to taxes based on a measure of net income. As such, the excise tax would not be considered an income tax subject to accounting under ASC 740.
ASC 505-30, Equity – Treasury Stock, governs the accounting treatment when a company repurchases its common shares. The accounting can be different if the repurchase is intended to be treasury stock or is for retirement (fully or constructively).
Generally, a company should recognize treasury stock based on the ‘cost’ to repurchase its shares. However, ‘cost’ is not defined in ASC 505-30. In practice, many financial statement preparers have concluded that direct costs incurred to acquire treasury stock should be treated like stock issuance costs and added to the cost of the treasury stock by analogy. In some cases, a company may purchase shares in excess of market value, i.e., to prevent acquisition, settle litigation, or settle employment contracts. In these cases, a portion of the acquisition cost should be allocated to the other identified elements of the transaction.
Significant judgment will be required to determine the correct accounting treatment due to the unique facts and circumstances of each share repurchase. If you have questions, contact your FORVIS advisor.
As with other portions of the IRA, Treasury Regulations are expected to provide additional guidance on various provisions and definitions.
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