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October 10, 2022 at 10:09 AM
What You Need to Know
- The Inflation Reduction Act contains a new provision that would discourage stock buybacks by imposing a new tax on such transactions.
- Some critics worry that discouraging stock buybacks could further exacerbate the pains felt by investment portfolios that are already in a slump due to shaky market conditions.
- The change may inspire more companies to pay special dividends, which may not have the same tax deferral value to investors as buybacks.
Publicly traded corporations often use a stock buyback strategy when they believe that their shares are undervalued. To increase value, they buy their own corporate shares to decrease the number of shares that are available on the market, thus concentrating the value of the remaining shares that are publicly available.
The Inflation Reduction Act contains a new provision that would discourage stock buybacks by imposing a new tax on such transactions. While the provision only applies to large publicly traded companies, the impact on individual investors shouldn’t be overlooked. Discouraging stock buybacks can have a wider impact, further exacerbating the pains felt by investment portfolios that are already in a slump due to today’s shaky market conditions.
Stock Buyback Excise Tax: The Basics
The Inflation Reduction Act of 2022 added a new 1% excise tax on stock buybacks. The tax is imposed on the fair market value of stock that a covered corporation purchases in any given year, less the value of any stock that was issued by the same corporation that year.
The tax only applies to the fair market value of stock repurchased by “covered corporations,” which include domestic corporations whose stock is publicly traded on an established securities market. The tax also applies in cases where a corporation purchases stock of an affiliate (defined as a corporation if more than 50% of its stock is held, directly or indirectly, by the purchasing corporation).
As the law is written, the excise tax would apply broadly to all types of stock that a covered corporation has issued. The new law also allows the Treasury Department to impose the stock buyback excise tax on transactions that are substantially similar to stock buyback transactions.
Exceptions to the New Rule
Not all transactions trigger the new stock buyback tax. The excise tax does not apply if the repurchase is part of a reorganization and no gain or loss on the stock repurchase is recognized. It also does not apply in situations where the repurchased stock is contributed to an employer-sponsored retirement plan, employee stock ownership plan (ESOP) or similar plan (or if an amount of stock equal to the value of the stock repurchased is contributed to such a plan).
