IRS Issues Initial Guidance on the New 1% Excise Tax on Certain Stock Buy-Back Transactions
The 1% excise tax on certain stock buy-back transactions (the Excise Tax) that was enacted as part of the Inflation Reduction Act of 2022 (IRA) went into effect on January 1, 2023. You can find more information about the Excise Tax and other provisions of the IRA in our previous alert (link here).
On December 27, 2022, the IRS issued Notice 2023-2 (Notice), which provides interim guidance on the implementation of the Excise Tax. The Notice provides guidance on how the Excise Tax is calculated, clarifies the type of transactions that are subject to the Excise Tax, and implements procedures for reporting and paying the Excise Tax. The Treasury and the IRS are seeking comments on the Notice and therefore changes are possible once proposed regulations are issued; however, taxpayers may rely on the Notice until the issuance of such proposed regulations by Treasury.
The Excise Tax is a non-deductible 1% tax on the fair market value of corporate stock repurchased in certain transactions occurring after December 31, 2022. Generally, the Excise Tax applies to stock repurchases by publicly traded U.S. corporations (Covered Corporations), certain affiliates of Covered Corporations (generally those owned 50% or more by the Covered Corporation) and may apply to direct or indirect repurchases of stock of a foreign corporation by its U.S. subsidiaries.
Excise Tax Calculation
The Excise Tax is calculated by multiplying the 1% tax rate by the “stock repurchase excise tax base.” The stock repurchase excise tax base is the aggregate fair market value of all stock repurchases by the Covered Corporation for the taxable year reduced by excluded transactions and certain stock issuances (provided under a netting rule).
If, in the aggregate, a Covered Corporation repurchases less than $1,000,000 of stock in a tax year, the Excise Tax does not apply (De Minimis Rule). The Notice clarifies that the De Minimis Rule is determined before taking into account any statutory exceptions and adjustments under the netting rule.
Timing and Fair Market Value
The Notice generally provides that stock is considered repurchased by the Covered Corporation at the time the stock is deemed to change ownership from a shareholder to the Covered Corporation or the applicable acquiror. The Notice also provides generally that the fair market value of repurchased stock is the “market price” of the repurchased stock, regardless of the repurchase price of such stock. Additionally, the Notice includes rules for determining the “market price” of repurchased stock.
The Internal Revenue Code defines a repurchase to include redemption transactions and “economically similar” transactions. In general, a redemption transaction is any acquisition of stock by its issuer. The Notice defines redemptions broadly to include transactions that constitute redemptions for federal income tax purposes, which includes more than just a typical corporate stock repurchase program.
Among the transactions the Notice defines as economically similar transactions is a redemption by a Covered Corporation of preferred stock, even if the redemption is mandatory or the preferred stock is not publicly traded. The Excise Tax would also apply to a leveraged acquisition, if a portion of the acquisition is treated as a redemption for income tax purposes and, even if as a result of this acquisition, the Covered Corporation would no longer be a Covered Corporation.
The Notice provides an exclusive list of transactions that are “economically similar” to a redemption. However, this list is subject to various exceptions, which taken together may render the Excise Tax zero. More particularly:
- While a redemption that occurs as a result of an acquisitive tax-free reorganization is a repurchase, the Excise Tax would apply only to the portion of stock that is exchanged for cash or other property (i.e., boot), and not to the consideration received tax-free. The same rule – that only boot is subject to the Excise Tax – also applies in the case of a tax-free recapitalization, tax-free F Reorganization (a mere change in identity, form, or place of incorporation), and split-off transactions that qualify under Code Section 355 for a tax-free treatment.
- If a Covered Corporation redeems its stock in connection with certain liquidating distributions, and if the Covered Corporation is owned at least 80% by a single domestic corporation and the remaining stock is widely held, only the portion of the stock that is redeemed from the minority shareholders is subject to the Excise Tax.
Under the Notice, if a transaction is not a “redemption” and not an “economically similar” transaction (as listed above), the transaction is not subject to the Excise Tax. The Notice provides a non-exclusive list of transactions that fall into this category:
- If a transaction is a complete liquidation transactions that is either fully taxable (under Section 331) or fully non-taxable (under section 332(a)), amounts paid by the Covered Corporation for its stock are not subject to the Excise Tax.
- Divisive spin-off transactions, other than split-off transactions (which are discussed above) that qualify as tax-free distributions of controlled corporation stock in exchange for Covered Corporation stock under Code Section 355, are not subject to the Excise Tax.
Ballard Spahr Observation. The clarification that a complete liquidation is not is subject to the Excise Tax is good news to some Special Purpose Acquisition Companies (SPAC), but the relief provided by the Notice is not as broad as had been hoped for and, at this stage, it is clear that redemptions that occur in connection with certain types of de-SPAC transaction structures would be subject to the Excise Tax.
Lastly, the Notice provides an exclusive list of transactions that are not a “repurchase” even though for income-tax purposes such transactions would be treated as a redemption: (i) brother-sister sales of controlled corporation stock where an acquiring corporation distributes property in exchange for stock in a commonly controlled corporation; and (ii) cash paid in lieu of fractional shares in certain non-recognition transactions.
Reductions to the Excise Tax and the Netting Rule
The stock repurchase excise tax base generally is reduced by the market price of repurchased stock or issued stock in the following statutory exception transactions:
- Stock repurchased by the Covered Corporation and contributed to an Employer-Sponsored Retirement Plan.
- Stock repurchased by a Covered Corporation that is a dealer in securities (subject to additional requirements).
- Stock repurchased by a Covered Corporation that is a Regulated Investment Company (RIC) or Real Estate Investment Trust (REIT).
- Stock repurchase transactions treated as a dividend under Code Sections 301(c) or 356(a)(2). Stock repurchase transactions that are subject to Code Sections 302 or 356(a) are presumed not to be dividends, however, this presumption may be rebutted by the taxpayer with certain evidence.
In addition, the aggregate fair market value of stock issued or provided by the Covered Corporation in the same tax year (including to employees) reduces the stock repurchase excise tax base. The netting rule is subject to various exceptions for certain transactions that will not constitute “issuances” (e.g., stock splits, issuances to a specified affiliate, issuances in connection with transactions that do not constitute repurchase, etc.). The Notice provides a special transition rule for fiscal year taxpayers under which a taxpayer may include as a reduction all issuances of stock during the tax year, including issuances that occurred in 2022.
Reporting and Record Keeping
The Notice provides for annual reporting of the Excise Tax using IRS Form 720 (quarterly federal excise tax return which will include a new schedule for calculating the Excise Tax). The Excise Tax is paid in conjunction with the filing of IRS Form 720 that is due for the first full quarter following the end of the tax year. For calendar year taxpayers, the due date is April 30. No extensions to report or pay the tax will be allowed.
For questions about the Excise Tax and the Notice or any other tax issues, please contact a member of Ballard Spahr’s Tax Group.
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