THINKING OF A CORPORATE STOCK BUYBACK? THINK AGAIN
Since 1982, when the practice was first permitted, corporations have put more money into buying their own stocks than every other type of investor (mutual funds, individuals, pension funds) combined. Described as a tax-efficient method to return value to shareholders, stock buybacks reduce the number of outstanding shares, therefore increasing earnings per share, and theoretically raising the company’s share price, at least in the short-run.
Beginning in the 1980s, boards began granting C-class executives large chunks of company stock and options in the interest of incentivizing them to raise “shareholder value.” Simultaneously, the Securities and Exchange Commission loosened their rules regarding stock buybacks which they previously deemed too dangerous of a market manipulation tool.
Companies tend to repurchase shares when the market price appears undervalued. Repurchases tend to occur when the company has cash to spare. Companies may choose to pay dividends with that extra cash, but that could lead to adverse tax consequences to the shareholders who receive those dividends. Alternatively, companies can buy back its own shares, reducing the number of shares outstanding and therefore earnings per share. Thus, the share price could get a boost, and value may be returned to the shareholder.
Shareholders who choose to sell their stock back to the corporation may experience capital gains and pay tax on those gains. Shareholders who do not sell, still realize value, and perhaps an unrealized gain, but with no immediate tax consequences. Although tax is paid on capital gains, it is only the ‘gain’ portion that is taxed. Conversely, shareholders generally pay tax on 100% of dividends received.
Often accused of contributing to income inequality, stock buybacks have a reputation for enabling C-class executives to profit from this short-term price bump. Democrats such as Bernie Sanders, Elizabeth Warren, and Chuck Schumer often decry stock buybacks as an unfair business practice that enrich corporate executives and wealthy shareholders.
Enter the new 1% Excise Tax on Corporate Stock Buybacks. Attributable to stock buy backs occurring after December 31, 2022, and part of the Inflation Reduction Act of 2022, the new tax is set to raise $74 billion over the next 10 years, curb stock buybacks, and encourage reinvestment by public companies.
The tax is calculated based on the fair market value (FMV) of stock that the corporation repurchases during the tax year. Attributable to U.S. corporations whose stock trades on an established securities market, the taxable amount is reduced by the FMV of new stock issued by the corporation during the tax year.
领英推荐
The FMV of stock issued during the year includes stock issued as compensation (including stock option exercises) or stock issued for the purpose of making acquisitions. It is not yet clear, however, whether an issuance of restricted stock would qualify or whether the effect of the issuance of restricted stock does not take effect until the restricted stock vests or if an 83(b) election is made. Stock issued related to ISO exercises appear to count even though the exercise may not be taxable to the employee.
The excise tax is not applicable to stock repurchases connected with a tax-free reorganization, or if the repurchased stock is contributed to an employer retirement plan or employee stock ownership plan (ESOP). There is also an exception for small buybacks totaling under $1 million during the tax year.
The tax is applicable to all stock of the corporation, whether publicly traded or not (e.g. preferred stock issued in a private offering). The tax is also applicable to stock buy backs of affiliated companies of the taxpayer, including buy backs of foreign affiliates that trade on an exchange. However, stock buybacks treated as dividends are generally exempt from the excise tax.
The tax is applicable to buybacks occurring after December 31, 2022. This is true for fiscal year taxpayers that may have a tax year beginning prior to December 31, 2022 and ending after December 31, 2022. What is unclear, is whether issuances by such taxpayers prior to December 31, 2022 would qualify as adjustments towards the tax.
Please contact Bass Tax Group to assist in addressing any questions you may have regarding these developments.
Neil Bass – (973) 240-7400 x500, [email protected]