On August 16, 2022, President Biden signed into law the Inflation Reduction Act (IRA). The IRA made a variety of changes to the Internal Revenue Code (Code). This Alert discusses four of the changes: the one percent excise tax on repurchases of public company stock, the corporate minimum tax, the extension of the expiration of the disallowance of excess business losses for non-C corporation taxpayers, and the increase in the research and development credit for qualified small businesses. A future Alert will address certain tax credits that were added to the Code or amended by the IRA.
Excise Tax on Repurchases of Public Company Stock
The IRA includes a new excise tax on repurchases of stock of “covered corporations.” A covered corporation is any domestic corporation (and some foreign corporations) the stock of which is traded on an established securities market. The tax is one percent of the fair market value of the repurchased shares, and it is nondeductible. This tax is effective for stock repurchases made after December 31, 2022, and the IRA includes no grandfathering rule for repurchases approved or authorized prior to the effective date.
A taxable repurchase is an acquisition of stock from a shareholder of a covered corporation in exchange for cash or other property. The tax applies not only to repurchases of stock by the covered corporation itself but also to purchases by the covered corporation’s corporate and partnership subsidiaries in which it owns more than 50 percent of the equity (specified affiliates). The tax is imposed on repurchases of all of the stock of a covered corporation, both common and preferred, and it applies whether or not the particular class of repurchased stock is publicly traded. Moreover, it applies to transactions that are “economically similar” to a repurchase, although there currently is no guidance on what constitutes an “economically similar” transaction.
The taxable amount of repurchased shares is reduced by the fair market value of stock that is issued by a covered corporation during the same tax year, including stock issued to employees of the covered corporation or of a specified affiliate.
Traditional stock buyback programs, tender offer purchases, and open market purchases pursuant to a stock repurchase plan, all are subject to the tax. For example, the tax includes stock tendered back to a covered corporation to pay taxes and exercise prices with respect to stock compensatory awards. The tax also may apply to public company stock repurchased in connection with a merger and acquisition (other than for the limited exclusion for certain tax-free reorganizations described below).
The new tax contains several express exclusions.
- The tax does not apply to shares repurchased as part of a tax-free reorganization under Code Section 368(a). This exclusion, however, only applies to shares repurchased in exchange for replacement securities where no gain or loss is recognized, and does not cover repurchases for cash (or “boot”). Stock repurchased in connection with tax-free transactions governed by other Code sections—such as a tax free spin off—does not fall within this exception.
- The tax does not apply when the repurchased stock (or an amount of stock equal to the value of the repurchased stock) is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan. This exclusion includes shares purchased by a qualified retirement plan and allocated in a tax year.
- The tax does not apply if the total value of repurchased stock of a covered corporation for a tax year does not exceed $1 million.
- The tax does not apply to a repurchase that is treated as a dividend for federal income tax purposes.
- The tax does not apply to the repurchase of stock by a dealer in securities in the ordinary course of business by a regulated investment company or by a real estate investment trust.
Corporate Minimum Tax
The IRA includes a corporate alternative minimum tax (AMT) that is imposed on applicable corporations. This new AMT is based on book income (with certain adjustments) and is intended to tax big multinational corporations that have significant book income but pay a low amount of or no tax. Following is a summary of some of the provisions of this new AMT.
An applicable corporation is a corporation, other than an S corporation, regulated investment company, or real estate investment trust, that together with its controlled group (all persons treated as a single employer with such corporation under Code Sections 52(a) or 52(b)) (Controlled Group) satisfies the adjusted financial statement income test (AFSI Test). In general, the AFSI Test is satisfied if the corporation has average annual AFSI for the three years ending prior to the current year exceeding $1 billion. The AMT applies only to the extent that 15 percent of AFSI exceeds the corporation’s regular federal corporate income tax and the AMT applies to taxable years beginning after December 31, 2022.
For foreign-parented multinational groups (FPMG), the AFSI Test is satisfied for a particular taxable year if (1) the corporation and all members of its FPMG has average annual AFSI for the three-year period of at least $1 billion and (2) during the testing period, the corporation has average annual AFSI of at least $100 million considering only the U.S. members of the corporation’s multinational group. A FPMG is a group of two or more entities that include at least one domestic corporation and one foreign corporation, that are included in the same applicable financial statement and that have, or are treated as having, a common parent that is a foreign corporation. U.S. subsidiaries of foreign parent corporations may not have sufficient information to determine if this test is satisfied. It will be important for foreign parent corporations to understand these rules and provide adequate information to their U.S. subsidiaries.
A corporation’s AFSI for any tax year is its net income or loss of the corporate taxpayer as set forth on its applicable financial statement (AFS) as defined in Section 451(b)(3) of the Code or as otherwise set forth in regulations. An AFS generally is a financial statement prepared in accordance with GAAP or IFRS that is required to be filed with the Securities and Exchange Commission (SEC) or similar foreign agency or, if no financial statement is required to be filed with the SEC, an audited financial statement used by the corporation for nontax purposes. This includes items of book income or gain that are not taxable income or gain—for example, certain spin-offs can produce book income but are tax-free. Accordingly, corporations should carefully analyze and compare the accounting implications of certain transactions in comparison to the tax treatment.
A corporate taxpayer’s and its Controlled Group’s AFS is subject to a variety of adjustments to arrive at annual AFSI. These adjustments (i) include causing financial statement income to include financial statement income related only to the particular year, (ii) are made to include only certain income from consolidated entities, (iii) eliminate dividends from consolidated groups corporations, (iv) include only certain foreign income, (v) adjust for payments of foreign taxes, (vi) include income of disregarded entities, and (vii) use tax depreciation as opposed to book depreciation. More guidance is needed to fully understand and evaluate how these adjustments would impact the book income. In addition, interest from all tax-exempt bonds is included in the taxpayer’s AFSI. These adjustments take into account certain book-tax differences but omissions from the adjustment list includes interest expense deduction limitations and Code Section 382 limitations on NOL deductions. A corporation that is a partner in a partnership takes into account only its distributive share (a term that is not defined) of the partnership’s AFSI. This AMT effectively requires impacted corporations to keep separate books and records from their regular tax or book records.
A corporation that is subject to the AMT determines its federal tax liability for a taxable year by calculating the excess of its “tentative minimum tax” over its regular tax liability. The tentative minimum tax is equal to 15 percent of AFSI for the taxable year less any corporate AMT foreign tax credit. General business credits generally may offset the AMT.
Excess Business Losses for Non-C Corporation Taxpayers
For taxpayers other than C corporations, the Tax Cuts and Jobs Act disallowed a deduction for excess business losses through the end of 2026. Excess business losses are the amount by which a non-C corporation taxpayer’s aggregate deductions attributable trades and businesses exceed the sum of (i) the aggregate gross income of the taxpayer attributable to trades and businesses and (ii) $262,000 for a single taxpayer or $524,000 for married taxpayers for 2022 (as adjusted for inflation). Excess losses are deductible in the following year. The IRA extended this disallowance for another two years through the end of 2028.
Increase of R&D Tax Credit to $500,000 for Qualified Small Businesses
Since 2016, a “qualified small business” has been able to apply up to $250,000 of Code Section 41 research and development (R&D) tax credits against the employer portion of the Social Security tax. This has allowed small businesses, including many in the technology and life sciences sectors, without enough income to take full advantage of R&D credits to monetize the credits. For these purposes, a “qualified small business” a trade or business with less than $5 million in gross receipts in the current tax year and that have been in existence for five or fewer years. Effective for tax years beginning on or after January 1, 2023, the IRA doubles the maximum amount of R&D credits that can be applied to offset employer payroll taxes to $500,000 and allows a qualified small business to apply the R&D tax credits against the employer portion of the Medicare tax.If you have questions about the IRA or other tax issues, please contact a member of Ballard Spahr’s Tax Practice Group.
- For this purposes, entities (corporations, partnerships, or trades or businesses) that are under common control in certain parent subsidiary groups, brother sister groups, and combined groups are aggregated. These aggregation rules are very complex and very unclear in application. In light of these aggregation rules, the potential application of the AMT should be considered in the context of structuring acquisitions and divestments. We note that the application of these rules to private equity funds was narrowed by a last minute amendment, the application of which is not entirely clear.
- When calculating a business’ gross receipts, Controlled Group rules similar to those described above may require multiple entities to be treated as a similar business when there is common ownership and/or control.
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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.