Treasury Issues Notice 2023-2, Clarifying Application of the Stock Buyback Excise Tax

On December 27, 2022, the IRS and Treasury issued Notice 2023-2 (the Notice), providing guidance on the stock buyback excise tax that was created by the Inflation Reduction Act of 2022. We previously summarized the stock buyback excise tax here.

As discussed in our previous post, the stock buyback excise tax imposes a 1% excise tax on the fair market value of repurchased stock of covered corporations for repurchases that occur after December 31, 2022. Covered corporations generally are domestic corporations whose stock is traded on an established securities market. Repurchases are defined as (i) redemptions within the meaning of Section 317(b) of the Internal Revenue Code of 1986, as amended (the Code), and (ii) any other transaction determined by the Secretary of the Treasury to be economically similar to such a redemption.  Section 317(b) of the Code defines redemptions broadly to cover any transaction where a corporation acquires its stock from a shareholder in exchange for property.

Guidance on Excluded Transactions 

The Notice provides the following exclusive list of transactions that are redemptions under Section 317(b) of the Code but are nevertheless not subject to the stock buyback excise tax:

1. Deemed distributions under Section 304(a)(1) of the Code (generally, these are deemed distributions where one corporation acquires stock of another corporation from a person (or persons) who hold 50% control over both corporations).
2. Payments of cash in lieu of fractional shares if:
   1. The payment is carried out as part of a tax-free reorganization under Section 368(a) of the Code or a spin-off under Section 355 of the Code;
   2. The cash received by the shareholder is not separately bargained-for consideration;
   3. The payment is carried out solely for administrative convenience (i.e., solely for non-tax reasons); and
   4. The amount of cash paid to the shareholder in lieu of a fractional share does not exceed the value of one full share of stock of the corporation.

Guidance on Economically Similar Transactions

The statutory language of the stock buyback excise tax provides that it applies not only to redemptions described in Section 317(b) of the Code, but also to transactions that Treasury deems are “economically similar” to redemptions. The Notice provides the following exclusive list of economically similar transactions that will be treated as repurchases for purposes of the stock buyback excise tax:

1. Acquisitive Reorganizations. In an acquisitive reorganization (generally defined as a transaction that qualifies as a reorganization under Sections 368(a)(1)(A) (including by virtue of Sections (a)(2)(D) or (a)(2)(E)), (C), or (D) of the Code) involving the acquisition of a target corporation that is a covered corporation, the exchange by target corporation shareholders of their target stock is treated as a repurchase by the target corporation.
2. Recapitalizations. In a recapitalization of a covered corporation that qualifies as a reorganization described in Section 368(a)(1)(E) of the Code, the exchange by the shareholders of their stock is treated as a repurchase.
3. F Reorganizations. In a reorganization described in Section 368(a)(1)(F) of the Code (generally, a mere change in identity, form, or place of organization) involving the transfer of property from a covered corporation to another corporation, the exchange of stock by the transferor corporation shareholders is treated as a repurchase.
4. Split-offs. In a split-off described in Section 355 of the Code by a distributing corporation that is a covered corporation, the exchange by the shareholders of their distributing corporation stock for controlled corporation stock (and other property, if applicable) will be treated as a repurchase.
5. Partially Taxable Liquidations. In a complete liquidation of a covered corporation to which Sections 331 and 332(a) of the Code respectively apply to component distributions of the liquidation (i.e., the liquidation qualifies as tax-free to an 80% corporate shareholder, but taxable to minority shareholders), (i) each distribution to which Section 331 of the Code applies (i.e., the distribution to the minority shareholders)  is treated as a repurchase and (ii) the distribution to which Section 332(a) of the Code applies (i.e., the distribution to the 80% corporate shareholder) is not treated as a repurchase.

Determination of Tax Base

 The Notice clarifies that, from a technical perspective, the starting point for the determination of a covered corporation’s tax base with respect to a repurchase is the gross fair market value of the repurchased stock (which the Notice provides can be determined based on several acceptable methods).  The tax base is then reduced by the fair market value of the repurchased stock to which an exception applies.  Exceptions include stock repurchased in exchange for “qualifying property” (generally, stock of the covered corporation or another corporation that can be received tax-free pursuant to Section 354 or 355 of the Code) and the fair market value of repurchased stock to the extent that the repurchase is treated as a dividend under Section 301(c)(1) or 356(a)(2) of the Code.

Because of these exceptions, in a tax-free transaction involving a covered corporation that technically is a “repurchase” for purposes of the stock buyback excise tax, the tax generally only applies to the portion of any taxable property (i.e., boot) received in such transaction that is treated as generating capital gain (i.e., not treated as a dividend). 

Guidance on Transactions that are not Economically Similar

The Notice provides the following nonexclusive list of transactions that are not economically similar to a redemption and thus not subject to the stock buyback excise tax:

1. Fully Taxable or Tax-Free Liquidations. Except as noted above, a distribution in complete liquidation of a covered corporation to which Section 331 or 332(a) of the Code applies is not a repurchase. If a covered corporation completely liquidates or dissolves during a taxable year in such a transaction, no distribution by that covered corporation during that taxable year is a repurchase.
2. Spin-offs. A distribution by a distributing corporation of stock of a controlled corporation that (i) qualifies under Section 355 of the Code and (ii) is not a split-off (as defined in the Notice), is not a repurchase.

Practical Implications and Lingering Questions

The Notice 2023-2 guidance effectively makes the stock buyback excise tax a transfer tax in connection with certain public M&A transactions.  This is specifically the case in such transactions involving repurchases (or deemed repurchases) of stock by a target corporation in exchange for non-stock property.

Taxability of Public M&A Transactions 

Transactions with a significant stock consideration component are often structured to qualify as tax-free under one or more provisions of the Code.  Because the stock buyback excise tax generally applies to the non-stock portion of the consideration received in a reorganization, but not to property received in a fully taxable transaction, the parties to M&A transactions may consider whether it makes sense to structure an acquisition with part-stock, part-cash consideration as fully taxable. 

Moreover, as noted above, the stock buyback excise tax applies to acquisitive reorganizations, which the Notice defines as transactions that qualify under the enumerated subsections of Section 368 of the Code. Such qualification does not need to be exclusive, meaning that a transaction that qualifies as a reorganization under Section 368(a) of the Code (including by virtue of Section 368(a)(2)(D) or 368(a)(2)(E) of the Code) as well as Section 351 of the Code (e.g., in a double-dummy transaction) would nevertheless be subject to the stock buyback excise tax.  Overlap with a reorganization described in Section 368(a)(1)(B) of the Code (which is not an “acquisitive reorganization” under the Notice’s definition) would generally not be relevant given that no boot can be received in such a reorganization, meaning that the tax base would generally be zero, even if the transaction also qualified as an acquisitive reorganization (e.g., under Section 368(a)(2)(E) of the Code).

The excise tax applies to the redemption portion of a Zenz-style acquisition of a covered corporation (i.e., a transaction where a target is acquired by a redemption of a portion of the seller’s shares accompanied by a cash purchase of the seller’s remaining shares) but not to the purchase price paid in a fully taxable transaction.  Consequently, all else equal, a buyer would generally be motivated to fund the entire purchase price rather than structuring the transaction as a partial redemption, even if it expects to access the target’s cash post-closing as part of its funding of the deal.  Other factors such as incremental borrowing costs would need to be weighed against the cost of the tax.

A typical SPAC liquidation would not be subject to the stock buyback excise tax.

Stock Buyback Excise Tax Reporting and Payment

The Notice provides that covered corporations will have to report their buyback taxes on an annual basis on the Form 720 that is due for the first full quarter after the end of their taxable year. Payment will be due at the Form 720 filing deadline, with no extensions permitted for either reporting or payment.