What Is the Stock Buyback Excise Tax?

The Inflation Reduction Act of 2022 created a 1% excise tax on the net value of stock repurchases by certain corporations, applying to buybacks after December 31, 2022. The measure addresses the different tax treatment between distributing earnings through dividends versus stock repurchases. This tax is non-deductible, meaning a corporation cannot subtract the amount from its taxable income.

Determining Applicability

The stock buyback excise tax applies specifically to entities defined as “covered corporations.” A covered corporation is a domestic corporation whose stock is traded on an established securities market. This market is not limited to major exchanges like the NYSE or NASDAQ but also includes certain foreign securities exchanges and interdealer quotation systems, ensuring a wide range of publicly traded companies are subject to the rule.

The tax’s reach extends beyond domestic corporations in specific scenarios. For instance, the U.S. subsidiary of a publicly traded foreign corporation may be subject to the tax if it funds a stock repurchase by its foreign parent with a principal purpose of avoiding the tax. This “funding rule” is designed to prevent companies from using their U.S. affiliates to circumvent the excise tax. A rebuttable presumption of an avoidance purpose exists if a U.S. subsidiary provides funding to its foreign parent and the parent repurchases stock within two years.

Special rules also apply to other types of entities. The tax does not apply to Real Estate Investment Trusts (REITs) or Regulated Investment Companies (RICs), such as mutual funds. Conversely, the rules for Special Purpose Acquisition Companies (SPACs) can be complex, as transactions related to their formation and subsequent mergers may involve activities that fall under the definition of a repurchase.

Identifying Taxable Repurchases

Once a company is identified as a covered corporation, the next step is to determine which transactions constitute a taxable “repurchase.” A repurchase is defined as a corporation’s acquisition of its own stock from a shareholder in exchange for property, which usually means cash. This includes common open-market buybacks and tender offers, and the IRS has clarified that certain transactions deemed “economically similar” to a redemption are also included.

However, the law provides several statutory exceptions, exempting certain transactions from the tax base. A repurchase is not taxed under the following circumstances:

• It is part of a tax-free corporate reorganization, provided no gain or loss is recognized by the shareholder.
• The repurchased stock is contributed to an employee pension plan, Employee Stock Ownership Plan (ESOP), or a similar plan.
• The repurchase is made by a dealer in securities during the ordinary course of business.
• It is treated as a dividend for income tax purposes.
• The total fair market value of the corporation’s stock repurchases during the year is $1 million or less.

Calculating the Excise Tax

The calculation of the stock buyback excise tax begins with the aggregate fair market value (FMV) of all stock repurchased during the corporation’s taxable year. For publicly traded stock, the IRS allows several methods to determine the FMV on the date of the repurchase, including the daily volume-weighted average price, the closing price, or the average of the high and low prices for the day. This initial figure includes all transactions identified as repurchases, before considering any reductions.

The primary adjustment to the tax base comes from the “netting rule.” This rule allows a corporation to reduce the total FMV of its repurchased stock by the total FMV of any stock it issued during the same taxable year. Issuances that qualify for this reduction include stock provided to employees, shares sold in public offerings, and stock used to acquire another company. The value of the issued stock is also determined by its FMV on the date of issuance.

After applying the netting rule and subtracting the value of any repurchases that qualify for a statutory exception, the final tax base is determined. The excise tax liability is then calculated by multiplying this net amount by 1%. For example, if a corporation repurchases $500 million of its stock, issues $100 million of new stock to employees, and has $50 million in repurchases that are treated as dividends, the calculation would be ($500M – $100M – $50M) x 1%, resulting in a tax of $3.5 million.

Reporting and Paying the Tax

Corporations subject to the tax must report their liability annually on Form 7208, Excise Tax on Repurchase of Corporate Stock, which is filed as an attachment to Form 720, the Quarterly Federal Excise Tax Return. The forms and payment are due by the last day of the first full calendar quarter after the end of the corporation’s taxable year. For a company with a calendar year-end of December 31, the deadline is April 30 of the following year.

A special transition rule applies for the tax’s initial period. For any taxable year ending after December 31, 2022, and on or before June 28, 2024, the filing and payment deadline is October 31, 2024.