On August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (the IRA) into law. Among the provisions of the IRA is a nondeductible 1% excise tax on the repurchase of corporate stock (the Buyback Tax). The Buyback Tax is directly levied on repurchasing corporations, which means that corporations that currently have, or are considering, the adoption of stock buyback programs will need to include the Buyback Tax in the evaluation of the costs of any such program. Not all stock buybacks are covered by the tax, and there are a number of exceptions that may apply to limit the impact of the Buyback Tax, as discussed in more detail below. The Buyback Tax is effective for transactions occurring in taxable years after December 31, 2022.
The Buyback Tax
The Buyback Tax imposes on each “covered corporation” a nondeductible tax equal to 1% of the fair market value of any stock of the covered corporation which is repurchased by such corporation during taxable years after December 31, 2022, unless an exception applies.
Covered Corporation
A “covered corporation” is any domestic corporation the stock of which is traded on an “established securities market” as defined under applicable law, which generally includes a national securities exchange, which is officially recognized, sanctioned, or supervised by a governmental authority (and certain analogous foreign securities exchanges); regional or local exchanges; as well as an over-the-counter market.
Repurchase
A “repurchase” is (1) a redemption within the meaning of applicable law with regard to the stock of a covered corporation and (2) any transaction determined by the Secretary of the Treasury to be economically similar to a redemption under applicable law. In particular, stock is treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property—including money, securities, and any other property, but excluding stock in the corporation making the distribution (or rights to acquire such stock)—regardless of whether the stock so acquired is cancelled, retired, or held as treasury stock.
Acquisitions by Specified Affiliates. In addition to direct repurchases made by a covered corporation of its own stock, if a “specified affiliate” of a covered corporation acquires the stock of the covered corporation from a person who is neither the covered corporation nor a specified affiliate of such covered corporation, then the Buyback Tax treats the acquisition by the specified affiliate as a stock repurchase of the covered corporation by such covered corporation. For this purpose, a “specified affiliate” of a corporation is (1) another corporation more than 50% of the stock of which is owned (by vote or value), directly or indirectly, by such corporation, and (2) any partnership more than 50% of the capital interests or profits interests of which is held, directly or indirectly, by such corporation.
Adjustments. The amount of repurchases by a covered corporation subject to the Buyback Tax is reduced by the fair market value of any stock issued by the covered corporation during the taxable year, including the fair market value of any stock issued or provided to employees of a specified affiliate of such covered corporation during the taxable year, regardless of whether such stock is issued or provided in response to the exercise of an option to purchase such stock (the Adjustment).
Exceptions
Although the scope of the Buyback Tax is broad, the Buyback Tax has six important exceptions that, if applicable, prevent the Buyback Tax from applying to a stock repurchase. In particular, the Buyback Tax does not apply to a stock repurchase:
- that occurs in connection with a tax-free reorganization;
- in which the stock repurchased is contributed to employee-sponsored retirement plans, employee stock ownership plans, or similar plans;
- by a US regulated investment company or a US real estate investment trust;
- to the extent the total value of the stock repurchased by a covered corporation during the taxable year does not exceed $1 million;
- to the extent such stock repurchase is treated as a dividend for US federal income tax purposes; and
- in certain cases in which the stock repurchase is by a dealer in securities in the ordinary course of business.
Buybacks Involving Foreign Corporations
Acquisitions by Specified Affiliates. The Buyback Tax includes rules that apply to the acquisition of stock of a publicly traded foreign corporation by its US subsidiary from an unrelated party. Specifically, if a specified affiliate of an “applicable foreign corporation” acquires the stock of such foreign corporation from a person who is neither the foreign corporation nor another specified affiliate of such foreign corporation, then (1) the specified affiliate is treated as a covered corporation, (2) the acquisition is treated as a repurchase of the stock of the covered corporation by such covered corporation, and (3) the Adjustment is determined only with respect to stock issued or provided by such specified affiliate to employees of such specified affiliate. For this purpose, an “applicable foreign corporation” is any foreign corporation the stock of which is traded on an established securities market, as described above.
Covered Surrogate Foreign Corporations and Section 7874. The Buyback Tax contains rules that apply to US corporations that have entered into or will enter into an inversion transaction after September 20, 2021. In general, an inversion transaction that is subject to the rules of section 7874 occurs when a foreign corporation (FC) acquires the stock or assets of a US corporation (USC), and (1) if at least 60% of the stock of FC is owned, following the acquisition, by the former shareholders of USC by reason of their previous ownership of USC, and (2) the corporate group controlled by FC following the acquisition does not have business activities in FC’s country of incorporation that are substantial when compared to the total business activities of the group from a worldwide perspective. For purposes of the Buyback Tax, FC—provided that FC’s stock is traded on an established securities market for the applicable period—would be a “covered surrogate foreign corporation” and USC would be an “expatriated entity” with respect to FC.
Under the Buyback Tax, if publicly traded FC (a covered surrogate foreign corporation) repurchases its own stock, or a specified affiliate of FC acquires the stock of FC, then (1) USC (the expatriated entity with respect to FC) is treated as a covered corporation with respect to the repurchase or acquisition, (2) the repurchase or acquisition is treated as a repurchase of stock of a covered corporation by such covered corporation, and (3) the Adjustment is determined only with respect to the stock issued or provided by USC to employees of USC.
Treasury Regulations
The Buyback Tax tasks Treasury and the IRS with issuing Treasury Regulations as necessary or appropriate to carry out and prevent the avoidance of the purposes of the Buyback Tax. Congress specifically mentioned the promulgation of Treasury Regulations to (1) prevent the abuse of the Buyback Tax exceptions, (2) address special classes of stock and preferred stock, and (3) regarding the application of the Buyback Tax to foreign corporations.
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1. All section references herein are to the Internal Revenue Code of 1986, as amended (the Code), or the Treasury Regulations promulgated thereunder, unless otherwise indicated.
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