Stock buyback tax: IRS issues proposed regulations

Executive summary

On April 9, 2024, the IRS released two sets of proposed regulations under section 4501’s non-deductible 1% excise tax relating to certain repurchases of public company stock (the stock buyback tax). Tax practitioners have been waiting for these proposed regulations as the excise tax applies to stock buybacks beginning in 2023. The proposed regulations largely continue the broad path outlined in Notice 2023-2, yet provide some relief by narrowing the scope of deemed tax avoidance transactions within a foreign-parented group that result in an imposition of the stock buyback tax.

Stock buyback tax background

The stock buyback tax was enacted as part of the Inflation Reduction Act of 2022. Section 4501 applies to stock repurchases that take place after Dec. 31, 2022. Under section 4501, every “covered corporation” is subject to a 1% excise tax on the fair market value (FMV) of stock repurchases made after Dec. 31, 2022, during such covered corporation’s taxable year. A “netting rule” may apply which works to reduce the excise tax base by the FMV of certain issuances of stock made during the taxable year. In addition to the netting rule, there are several other statutory exceptions to the stock buyback tax.

The term “covered corporation” refers to any domestic corporation whose stock is traded on an established securities market (e.g., NYSE, certain foreign securities markets). The term “repurchase” means a section 317(b) redemption or economically similar transaction, which includes buybacks in connection with certain mergers, separations and M&A transactions involving affiliates.

In December 2022, the IRS issued Notice 2023-2 which provided guidance specifying the types of transactions that are considered repurchases that can trigger the stock buyback tax, describing transactions that are excepted from the stock buyback tax and outlining rules for determining the FMV of repurchased stock. We posted a Tax Alert on Notice 2023-2 that provides more insight, here.

Proposed regulations released

Following the enactment of section 4501 and the issuance of Notice 2023-2, the Treasury and IRS received numerous comments from interested parties. On April 9, 2024, the Treasury and IRS issued two sets of proposed regulations that provide guidance regarding the application of the stock buyback tax.

The first set of proposed regulations (REG-115710-22) provides substantive guidance that applies to covered corporations and specified affiliates. The second set of proposed regulations (REG-118499-23) gives procedural guidance on the excise tax.

The notice attracted a considerable number of comments with respect to the so-called “funding rule.” The funding rule could apply if an applicable specified affiliate, such as a domestic subsidiary of a foreign parent, facilitates the purchase of stock of the foreign parent stock. Furthermore, the stock buyback tax is triggered when such financings are deemed to be repurchases with “a principal purpose” of circumventing the tax. According to the notice, “a principal purpose” is automatically assumed if the financing happens within two years of the related stock transaction by the financed entity, a criterion known as the "per se rule."

The proposed regulations modified the funding rule by narrowing it in some ways and broadening it in others. For example, the "per se rule" is replaced with a targeted rebuttable presumption rule that would deem a principal purpose to exist in more limited circumstances where the applicable specified affiliate funds by any means, including distributions, directly or indirectly, a "downstream relevant entity" and the funding occurs within two years of a covered purchase by or on behalf of the downstream relevant entity. A “downstream relevant entity” could be partially owned—through as little as 25% of stock by vote or value in the case of corporations, or 25% of capital or profits interests for partnerships—by one or more “applicable specified affiliates” such as domestic subsidiaries in a foreign-parented group. This represents a broader application than found in the notice.

Potential expansion of the stock buyback tax

The Biden Administration’s fiscal year 2025 budget included two revenue proposals related to the stock buyback tax:

1. Increase the tax by four times from the current 1% to 4%
2. Expand the reach of the stock buyback tax to include certain acquisitions of applicable foreign corporation stock by controlled foreign corporations (CFCs) of U.S. shareholders.

These proposals, along with the many others included in the budget, are President Biden's recommendations for federal funding and are aligned with his policy priorities. While their likelihood of enactment in our current divided government is low, taxpayers subject to the tax should be aware of the outstanding proposal.

Conclusion

Corporations whose stock is publicly traded should become familiar with the stock buyback rules as set forth in Notice 2023-2 and the proposed regulations. The rules governing the stock buyback tax are complex. Affected persons (e.g., covered corporations, shareholders and financial advisors) are urged to consult with their tax advisors if they participate in transactions involving corporations whose stock is publicly traded.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments. Baker Tilly US, LLP does not practice law, nor does it give legal advice, and makes no representations regarding questions of legal interpretation.