The U.S. Department of the Treasury recently finalized, with minor modifications, a set of proposed procedural regulations (REG-118499-23) regarding the payment and reporting of the excise tax on repurchases of corporate stock (Stock Repurchase Excise Tax) levied by Section 4501 of the Internal Revenue Code (IRC) for repurchases made after December 31, 2022. Proposed substantive regulations (REG-115710-22) are not finalized at this time and Treasury and the IRS are still considering comments received. A public hearing has been scheduled for August 27, 2024 regarding the proposed substantive regulations.
Prior to the proposed and finalized regulations, the IRS released Notice 2023-2 (Notice) providing limited guidance on the Stock Repurchase Excise Tax. The proposed and finalized regulations replace the rules outlined in the Notice, and barring certain exceptions, are generally consistent with the guidance provided in the Notice.
With the issuance of the finalized procedural regulations, taxpayers will need to be cognizant of the upcoming reporting and payment due dates. For example, a taxpayer with a taxable year ending December 31, 2023 that made stock repurchases, as defined in §4501(c), is required to file the Stock Repurchase Excise Tax return for its 2023 taxable year by the due date of the Form 720 for the first full calendar quarter after June 28, 2024. The due date for the Form 720 for the first full calendar quarter after June 28, 2024 is October 31, 2024.1
Overview
The Stock Repurchase Excise Tax was enacted as part of the Inflation Reduction Act of 2022 (IRA) signed into law on August 16, 2022. Section 4501 imposes an excise tax on certain repurchases of stock by publicly traded corporations.2
In general, an excise tax is assessed on each covered corporation equal to 1% of the fair market value (FMV) of any stock of the corporation repurchased during the taxable year. The excise tax applies to repurchases of stock by covered corporations beginning after December 31, 2022. No deduction is allowed for the payment of the Stock Repurchase Excise Tax3 and is not capitalized to any asset for federal income tax purposes.
A “covered corporation” is defined as any domestic corporation the stock of which is traded on an established securities market within the meaning of §7704(b)(1). Treasury Regulation §1.7704-1(b) further defines an “established securities market” as a national securities exchange, such as the New York Stock Exchange (NYSE) or NASDAQ, and over-the-counter (OTC) markets.
Stock acquisitions of a covered corporation made by a “specified affiliate” (further defined in this article) is treated as a repurchase by the covered corporation. Certain acquisitions or repurchases of stock of foreign corporations that have stock traded on an established securities market, including foreign exchanges, also may trigger the excise tax.
The taxable amount of the repurchases is reduced first by the FMV of any repurchases that qualify for one of the several Statutory Exceptions, and second by the FMV of any stock issued by the covered corporation (netting rule).
The Statutory Exceptions comprise the following:
- Repurchases to the extent they are part of a reorganization within the meaning of §368(a) and no gain or loss is recognized on the repurchase by the shareholder
- Repurchases, or an amount of stock equal to the value of the stock repurchased, contributed to an employer-sponsored retirement plan, employee stock ownership plan (ESOP), or similar plan
- Repurchases in which the total FMV of stock repurchased during the taxable year is less than $1,000,000 (the de minimis exception) before applying a reduction for a Statutory Exception or the netting rule
- Repurchases made by a dealer in securities in the ordinary course of business
- Repurchases by a regulated investment company (RIC) or real estate investment trust (REIT)
- Repurchases to the extent they are treated as a dividend
Covered Corporation
As noted above, §4501 applies to repurchases made by a “covered corporation.” The proposed regulations provide that §4501 only applies during the period in which a corporation is considered a “covered corporation,” and such corporation becomes a “covered corporation” at the beginning of the corporation’s “initiation date,” which is the date the corporation’s stock begins trading on an established securities market. Further, a corporation would cease being a “covered corporation” at the end of the corporation’s “cessation date,” which is the date the corporation’s stock ceases trading on an established securities market.
The proposed regulations provide that in the case of a privately held domestic corporation that becomes public, shares issued on or after the initiation date would be counted for purposes of the netting rule and any repurchases, issuances, or contributions to an employer-sponsored retirement plan on or after that date would be taken into account in computing the tax. In the case of a publicly traded domestic corporation that goes private, repurchases of stock on the cessation date would be subject to the Stock Repurchase Excise Tax, unless one of the Statutory Exceptions apply, and any repurchases, issuances, or contributions to an employer-sponsored retirement plan after that date would not be taken into account in computing the tax. If a corporation ceases to be a covered corporation pursuant to a plan that includes a repurchase, the corporation will continue to be a covered corporation until the end of the date on which the repurchase occurs pursuant to the plan, even if the cessation date precedes the repurchase.
In addition, a foreign corporation that transfers its assets to a domestic corporation in a tax-free reorganization under §368(a)(1)(F), an F reorganization, will not be treated as a domestic corporation until the day after the reorganization. Similarly, a domestic corporation that transfers its assets to a foreign corporation in an F reorganization will not be treated as a foreign corporation until the day after the reorganization.
Specified Affiliate
The proposed regulations define a “specified affiliate” with regard to any corporation as, (i) any corporation more than 50% owned, directly or indirectly, by the corporation, and (ii) any partnership more than 50% of the capital or profits interests held, directly or indirectly, by the corporation.4 A corporation or partnership is a specified affiliate when it acquires stock of a covered corporation or provides stock of the covered corporation to employees of the potential specified affiliate.
Repurchases
Section 4501(c)(1) provides the term “repurchase” as (i) a redemption within the meaning of §317(b) with regard to the stock of the covered corporation (redemption), and (ii) any transaction determined by the Secretary of the Treasury to be economically similar to a §317(b) redemption. The proposed regulations clarify two exceptions for transactions considered redemptions under §317(b) that will not be considered repurchases, (i) §304(a)(1) transactions regardless of whether the deemed redemption is under §302(a) or 302(d), and (ii) certain payments of cash in lieu of a fractional share if the payment is carried out as part of a reorganization under §368, a distribution under §355, or pursuant to a settlement of an option or similar financial instrument.
The proposed regulations provide an exclusive list of transactions that are considered economically similar to a redemption for purposes of the Stock Repurchase Excise Tax:
- Acquisitive reorganizations, e.g., reorganizations described in §368(a)(1)(A), (C), and (D)) where the target corporation is a covered corporation
- Recapitalizations under §368(a)(1)(E) where the recapitalizing corporation is a covered corporation
- Reorganizations under §368(a)(1)(F) where the transferor corporation shareholders exchange their transferor corporation stock which is a covered corporation
- Split-offs qualifying under §355 where shareholders of the distributing corporation exchange stock for the controlled corporation and the distributing corporation is a covered corporation
- Complete liquidations of a covered corporation or a covered surrogate foreign corporation to which both §331 and 332(a) apply to component distributions of the complete liquidation, but only the §331 component distributions will be considered repurchases
The proposed regulations also provide a nonexclusive list of transactions that are not considered repurchases for purposes of the Stock Repurchase Excise Tax:
- A distribution in a complete liquidation of a covered corporation that either §331 or §332(a), but not both, apply
- A distribution pursuant to a deem dissolution of the covered corporation
- A distribution pursuant to the resolution or plan of dissolution of the covered corporation reported on original Form 966
- A distribution by a covered corporation of stock of a controlled corporation under §355 that is not a split-off
- A distribution subject to §301(c)(2) or 301(c)(3) in which the distribute does not exchange stock of the covered corporation
Stock
Stock for the purposes of §4501 is defined as any instrument issued by a corporation that is stock or that is treated as stock for federal tax purposes at the time of issuance5 (including Treasury stock), regardless of whether the instrument is traded on an established securities market. This definition of “stock” generally excludes options other than options that are treated as stock for federal tax purposes at the time of issuance, e.g., certain deep-in-the-money stock options6. However, for purposes of the netting rule, issuances of options that are treated as stock for federal tax purposes at the time of issuance are disregarded until the instrument is repurchased, and that the amount of the issuance under the netting rule would be limited to the less of FMV at the time of its issuance or repurchase.
The proposed regulations modify this definition to exclude “additional Tier 1 preferred stock” under certain applicable regulatory rules. Additional Tier 1 preferred stock is preferred stock that, (i) qualifies as additional Tier 1 capital, but (ii) does not qualify as common equity Tier 1 capital. An issuance or repurchase of additional Tier 1 preferred stock would be disregarded for purposes of the Stock Repurchase Excise Tax.
Funding Rule for Publicly Traded Foreign Corporations
Section 4501(d)(1) provides that7 in the case of an acquisition of stock of an applicable foreign corporation by a specified affiliate of such corporation (other than a foreign corporation or a foreign partnership, unless such partnership has a domestic entity as a direct or indirect partner) from a person who is not the applicable foreign corporation or a specified affiliate, such (i) specified affiliate shall be treated as a covered corporation with respect to the acquisition, and (ii) acquisition shall be treated as a repurchase of stock by a covered corporation.
The proposed regulations provide that if a domestic subsidiary of a publicly traded foreign corporation funds by any means (including through distributions, debt, or capital contributions) the repurchase or acquisition of stock of such foreign corporation and such funding is undertaken with a principal purpose of avoiding the Stock Repurchase Excise Tax, then such repurchase or acquisition will be subject to the Stock Repurchase Excise Tax in the U.S. even though the repurchases are made on a foreign stock exchange. Notice 2023-2 provided a per se rule stating that a principal purpose is deemed to exist if the applicable specified affiliate funds by any means, other than through distributions, the foreign corporation, and such funded entity acquires or repurchases stock within two years of the funding. The proposed regulations have replaced the per se rule with a rebuttable presumption that a principal purpose would be presumed to exist if the applicable specified affiliate funds by any means, 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 entity. The term “downstream relevant entity” is defined as a relevant entity (i) 25% or more of the stock owned, directly or indirectly, by one or more applicable specified affiliates, or (ii) 25% or more of the capital or profits interests owned, directly or indirectly, by one or more applicable specified affiliates. The rebuttable presumption may be rebutted if facts and circumstances clearly show there was not a principal purpose of avoiding the tax. There is, however, no tracing rule included in the proposed regulations to rebut the presumption that the funding was not connected to the repurchases by the foreign parent.
Reporting & Payment
The final procedural regulations provide that any covered corporation that makes a repurchase after December 31, 2022 must file a Form 720, Quarterly Federal Excise Tax Return, with an attached Form 7208, Excise Tax on Repurchase of Corporate Stock. Modified from the proposed regulations, the final regulations exempt RICs and REITs from the requirement to file a Stock Repurchase Excise Tax return as they qualify for a statutory exemption under §4501(e)(5). A draft Form 7208 is currently available, and a final version is expected to be re-released prior to the first due date for reporting the Stock Repurchase Excise Tax.
The Stock Repurchase Excise Tax must be reported once per taxable year on the Form 720 that is due for the first full quarter after the close of the taxpayer’s taxable year.8 The deadline for payment of the tax is the same as the filing deadline.
As noted above, for taxable years that ended on or prior to the issuance of the final procedural regulations, i.e., taxable year ending after December 31, 2022 and on or before June 28, 2024, the Stock Repurchase Excise Tax return for such taxable year must be filed by the due date of the Form 720 for the first full calendar quarter after June 28, 2024, i.e., October 31, 2024. If a covered corporation has more than one taxable year ending after December 31, 2022 and on or before June 28, 2024, they should file a single Form 720 with two separate Forms 7208 (one for each taxable year) attached. There is no filing requirement with respect to taxable years in which the covered corporation has not made a repurchase or an economically similar transaction. As there is not a consolidated form, members of the same affiliated group will need to each file a form to the extent they have either funded or made qualifying stock repurchases.
If you have questions or need assistance on the Stock Repurchase Excise Tax, please reach out to a professional at Forvis Mazars.
- 1“Internal Revenue Bulletin: 2024-29,” irs.gov, July 15, 2024.
- 2“New Stock Repurchase Excise Tax,” thetaxadviser.com, March 1, 2023.
- 3“Internal Revenue Bulletin: 2023-03,” irs.gov, January 17, 2023.
- 4“Internal Revenue Bulletin: 2023-03,” irs.gov, January 17, 2023.
- 5“Internal Revenue Bulletin: 2023-03,” irs.gov, January 13, 2023.
- 6“Internal Revenue Bulletin: 2024-20,” irs.gov, May 13, 2024.
- 7“Initial Guidance Regarding the Application of the Excise Tax on Repurchases of Corporate Stock under Section 4501 of the Internal Revenue Code,” irs.gov, November 2, 2023.
- 8“Internal Revenue Bulletin: 2023-03,” irs.gov, January 13, 2023.