The 1% excise tax was enacted into law in August 2022 as part of the Inflation Reduction Act of 2022 and applies to any publicly traded corporation that repurchases more than $1 million of its shares in a taxable year. Certain stock repurchases are exempted from application of the tax.
For example, to the extent a particular repurchase is nontaxable pursuant to Internal Revenue Code sections 368 and/or 355, the repurchase may be exempted from the repurchase tax. However, this exemption does not apply to payments of boot in connection with otherwise tax-deferred transactions, and stock repurchased in connection with a complete liquidation of a company may be exempted as well.
Key Implications for Four Common Corporate Transactions
While the guidance provides numerous exceptions that a savvy taxpayer can apply to avoid this 1% excise tax, the unsuspecting corporation could incur liability for this new tax in various circumstances, including:
1. Taxable Payments to Target Company Shareholders. Cash (or other nonstock) payments made to a publicly traded target company shareholder in connection with an acquisition may be subject to the stock repurchase tax. For example, leveraged buyouts and other bootstrap acquisitions typically involve the distribution of cash to the target company’s shareholders. These distributions would be subject to the 1% excise tax. Additionally, payments of boot in connection with an otherwise nontaxable Section 368 reorganization may also be subject to tax. While the target company would technically be responsible for any such tax, acquirers must account for any carryover liability in negotiations and documentation of the transaction.
Cash payments made in lieu of fractional shares may be exempted from taxation. Additionally, cash payments made in connection with taxable acquisitions treated as stock sales (or transactions treated as asset sales followed by a complete liquidation) may also be exempt.
2. De-SPAC Redemptions. Investors in a special-purpose acquisition company (SPAC) initial public offering typically have the right to redeem all or a portion of their SPAC shares in connection with a de-SPAC transaction. That is, in connection with a merger of a SPAC with a target company, certain shareholders exercise their rights to resell their SPAC shares back to the SPAC. In most cases, these redemptions will constitute taxable repurchases of SPAC company stock. As such, these transactions could be subject to the excise tax.
3. Complete Liquidations. As long as a publicly traded company is completely liquidated in full in a single tax year, liquidating distributions should not be taxable. However, if the liquidating distributions straddle multiple tax years, some or all of the distributions could be taxable. Additionally, if a SPAC is unable to acquire a target company within a contractually proscribed period, the SPAC is typically required to liquidate. In certain cases, the sponsors of SPACs do not receive distributions in connection with the liquidation of a SPAC. In those cases, it is unclear whether the complete liquidation exemption would apply.
Finally, in the case of a publicly traded corporation that is 80% owned by a single corporate parent entity, liquidating distributions made to the non-majority owners will likely be subject to the tax.
4. Spin-Offs, Split-Ups and Split-Offs. While spin-offs and split-ups pursuant to Section 355 are generally exempted, any cash or other boot distributions made pursuant to a split-off will be treated as a taxable repurchase. For reference, a split-off is the distribution of the stock of a controlled corporation to some, but not all, of the shareholders of a parent corporation.
Why It Matters
There are many complexities of the new guidance, and companies planning to engage in a variety of corporate transactions in 2023 will need to account for these tax implications in deal terms. While the above is not intended to be a comprehensive discussion of all corporate transactions that could give rise to a stock buyback excise tax liability and does not cover all the intricacies of the new excise tax, it does underscore the need for experienced tax counsel to help guide you through these changes. If you intend to engage in a transaction that could be treated as a stock repurchase, we encourage you to contact a member of Glaser Weil’s Tax Department to help address the implications of this new guidance.