IRS, Treasury Issue Interim Guidance on Stock Repurchase Excise Tax

The Inflation Reduction Act (IRA) enacted on August 16, 2022, created a new corporate excise tax on stock repurchases for taxable years beginning after December 31, 2022. On December 27, 2022, the Treasury Department and the Internal Revenue Service issued interim guidance -- Notice 2023-2 -- on the corporate excise tax. The notice addresses time-sensitive issues with the expectation that forthcoming proposed regulations will provide clarity on the statutory provision.

Excise Tax on Repurchases of Corporate Stock under §4501

The excise tax under the new Section 4501 of the Internal Revenue Code is a 1% tax imposed on the fair market value of stock redeemed during the taxable year, net of the fair value of stock issued. A redemption for these purposes is defined in Section 317(b) as any transaction in which a corporation acquires its own stock in exchange for property, whether or not the stock is retired, canceled or held in treasury. The statute also expands this definition to encompass any transaction the Secretary determines to be economically similar to a statutory redemption; the breadth of this definition is in large part the subject of Notice 2023-2.

The excise tax applies to redemptions by a “covered corporation,” which is generally a publicly traded domestic corporation. The statute expands this general rule in several ways:

• If a covered corporation has its stock purchased by a majority-owned affiliate (a “specified affiliate”), and that stock is acquired from a person that is neither the covered corporation nor an affiliate of such corporation, then the purchase is treated as though the covered corporation redeemed its own stock.
• If there is no covered corporation, but instead a publicly traded foreign corporation (referred to as an “applicable foreign corporation”) has its stock purchased by a domestic affiliate or certain foreign partnership affiliates, and similarly the purchase is made from an unrelated party, then the affiliate is treated as a covered corporation (although not itself publicly traded), and such a purchase is subject to the excise tax. 
• Lastly, if the publicly traded foreign corporation in the preceding paragraph is also a surrogate foreign corporation under the inversion rules of Section 7874 (with certain modifications), then repurchases by its affiliates or by the surrogate foreign corporation itself may result in its expatriated entity being treated as a covered corporation and subject to the excise tax as though it had made the repurchase.

However, the statute also excepts certain repurchases from excise treatment. Redemptions treated as a dividend for tax purposes are excepted, as well as repurchases by a RIC or a REIT. Also, under the de minimis rule, if total redemptions during the taxable year do not exceed $1 million in value, then the excise tax does not apply. Redemptions in the course of tax-free reorganizations where no gain or loss is recognized and redemptions in which the value of the stock repurchased is contributed to an ESOP or similar plan are also excepted. Finally, the statute directs the Secretary to issue regulations regarding repurchases made by securities dealers in the ordinary course of business.

Notice 2023-2

The notice expands on a number of the aforementioned statutory rules regarding which entities are subject to the excise tax, and which transactions those entities may or may not include in the computation. 

The notice expands on which transactions are considered “economically similar” to a repurchase, and therefore subject to the excise tax. These include:

• Acquisitive reorganizations that may include boot (i.e., types “A,” “C” and “D” reorganizations);
• Certain single-entity reorganizations, including recapitalizations (“E” reorganization) and mere changes in identity, form or place of incorporation (“F” reorganizations);
• Split-offs (involving a redemption of distributing stock, as opposed to spin-offs or split-ups, which are not considered repurchase transactions); and 
• Complete liquidations with respect to which both Section 331 and Section 332 apply. In such a liquidation scenario, only the Section 331 portion of the liquidation is treated as a redemption for excise tax purposes. 

With respect to reorganizations, only non-qualifying considerations (i.e., “boot”) would be subject to the excise tax. As mentioned above, under the statute, transactions in which no gain or loss is recognized would already be excepted.  

By contrast, neither the repurchase of fractional shares nor a deemed redemption pursuant to Section 304(a)(1) is treated as a repurchase for excise tax purposes. The exclusion of Section 304 applies to situations in which the transfer of property is determined to be a sale or exchange pursuant to Section 302(a), which does not appear to be symmetrical with the approach to reorganization boot (as explained below). In addition, liquidations under Section 331 or Section 332 (as opposed to a liquidation involving both provisions), as well as divisive Section 355 transactions other than split-offs are also excluded. 

The exclusion of complete liquidations appears to resolve a concern SPAC investors expressed when Section 4501 was enacted, that the “unfunding” of a SPAC entity would be subject to excise tax even when no target was ultimately identified. 

The notice also provides guidance on how the fair market value of a stock is determined on the date of repurchase. Acceptable methods include: 

• The daily volume-weighted average price as determined on the date the stock is repurchased; 
• The closing price on the date the stock is repurchased; 
• The average of the high and low prices on the date the stock is repurchased; and 
• The trading price at the time the stock is repurchased.

For these purposes, the date the stock is repurchased is not a trading day. The trading day is the date immediately preceding the date the stock is repurchased. 

The notice also expands the rules regarding acquisitions of applicable foreign corporation stock by including repurchases undertaken by the public foreign corporation or affiliate that were funded by an entity that would have triggered the aforementioned covered corporation treatment had such an affiliate undertaken the repurchase itself. This provision applies when a principal purpose of avoidance exists, but a per se rule applies if the funding occurs in a transfer other than a distribution (i.e., debt, capital contribution) within two years of the repurchase.

The excise tax will be reported on Form 720, Quarterly Federal Excise Return, which will include a computational attachment. Upcoming proposed regulations are expected to require reporting in the first quarter of the year following the taxable year for which the excise tax is imposed, without the possibility of extension. Thus, for a calendar year December 31 corporation, the first form would be due on April 30 of the following year. A draft form -- Form 7208, Excise Tax on Repurchase of Corporate Stock -- was issued on December 28, 2022.  

Finally, the notice requests comments from taxpayers on a number of issues, including whether special rules should apply to debt and redeemable preferred stock redemptions, and whether special rules should apply to redemptions that occur in the course of a bankruptcy or troubled corporation restructuring.