The IRS recently released Notice 2023-2 providing their initial guidance regarding the application of the excise tax on the repurchase of corporate stock. The notice provides interim guidance which taxpayers may rely on when applying the excise tax until final regulations are issued.
The excise tax, §4501, was enacted as part of the Inflation Reduction Act of 2022. Under Section 4501, covered corporations must pay a 1% tax on the fair market value of any corporate stock that the corporation repurchases during the taxable year. A repurchase occurs when a corporation acquires stock from a shareholder in exchange for property, whether the acquired stock is canceled, retired, or held as treasury stock. A covered corporation is a domestic corporation with stock traded on an established securities market.
Based on the definition of a covered corporation, §4501 could apply to domestic-incorporated special purpose acquisition companies (SPACs). SPACs generally refer to a shell company listed on a stock exchange with the purpose of acquiring a private company and, therefore, making it public without going through the traditional IPO process. Investors choose to invest in a SPAC, where the investor proceeds are kept in trust to acquire a future target. Oftentimes, a SPAC has a shortened period of time, somewhere between 18 to 24 months, to acquire a target. If the SPAC does acquire a target during this time period, they are generally required to dissolve. Before the excise tax rules of section 4501, the dissolution would entitle investors to their pro rata portion of money contributed, interest income earned, less expenses. After the excise tax was enacted, many feared the utilization of SPACs would decrease due to the mandatory excise tax decreasing the pro rata distributions upon liquidation and questioned a trust’s legal ability to distribute related funds to the excise tax liability.
Complete Liquidation of Covered Corporation Where Only §331 Applies
The recent IRS Notice provided welcomed relief that the excise tax would not apply to Section 331 liquidations, amounts received by shareholders in a distribution in complete liquidation.
If a covered corporation or a covered surrogate foreign corporation (as appropriate) completely liquidates and dissolves (within the meaning of § 1.331-1(d)(1)(ii)) during a taxable year (that is, has a final distribution in complete liquidation to which § 331 applies during that taxable year), no distribution by that covered corporation or covered surrogate foreign corporation during that taxable year is a repurchase.
For example, assume Corporation X adopts a plan of complete liquidation that becomes effective on March 1, 2023. Corporation X has 100x shares of common stock outstanding. On April 1, 2023, all shareholders of Corporation X receive a liquidating distribution by Corporation X in full payment for their Corporation X common stock. At the time at which Corporation X distributes all of its corporate assets to its shareholders in complete liquidation, Corporation X stock trades at $1x per share. Each distribution in complete liquidation is subject to § 331. Therefore, none of the distributions by Corporation X in complete liquidation is a repurchase by Corporation X, and Corporation X’s stock repurchase excise tax for its 2023 taxable year is not increased as a result of the Corporation X liquidation.
Complete Liquidation of Covered Corporation Where Both §331 and §332 Applies
However, if a distribution is in complete liquidation of a covered corporation to which both §331 and §332 apply, the excise tax will not apply to the distribution that falls under §332 but will apply to the distribution deemed part of the §331 distribution.
For example, assume Corporation X adopts a plan of complete liquidation that becomes effective on March 1, 2023. One of Corporation X’s shareholders is a corporation (Corporation Z). As of the date of adoption of the plan of liquidation of Corporation X, Corporation Z is the owner of 80x shares of Corporation X common stock. The remaining 20x shares are held by other shareholders. The liquidating distribution by Corporation X to Corporation Z as part of the Corporation X Liquidation qualifies as a liquidation under § 332(a). The liquidating distributions by Corporation X to the other shareholders are distributions in liquidation subject to § 331. As a result of the component liquidating distributions of the Corporation X liquidation to which § 331 applies, Corporation X is deemed to repurchase 20x shares of its stock on April 1, 2023. Accordingly, the Corporation X liquidation results in an increase in Corporation X’s stock repurchase excise tax base for its 2023 taxable year in relation to the 20x shares.
Redemption Without Liquidation
If a SPAC redeems shares outside a Section 331 liquidation, the SPAC could be subject to the excise tax. The stock repurchase excise tax is equal to 1 percent of the fair market value of any of the stock repurchase excise tax base. The fair market value of repurchased stock is the market price of the stock on the date the stock is repurchased.
If the stock is traded on an established market, the taxpayer can determine the market price by applying one of four methods:
- 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; or
- The trading price at the time the stock is repurchased.
If repurchased stock is not traded on an established securities market, the determination of the fair market value of the stock must be based on the reasonable application of a reasonable valuation method. The factors to be considered for determining whether a valuation method is reasonable include the value of tangible and intangible assets of the corporation; the present value of anticipated future cash flows of the corporation; the market value of stock or equity interests in similar corporations and other entities engaged in trades or businesses substantially similar to the corporation, the value of which may be readily determined through nondiscretionary, objective means (such as through trading prices on an established securities market or an amount paid in an arm’s length transaction); recent arm’s length transactions involving the sale or transfer of such stock or equity interests; and other relevant factors.
The amount of the stock repurchase excise tax base determined after totaling the FMV of repurchases made by the covered corporation during the taxable year is reduced by:
- The fair market value of the stock of the covered corporation repurchased during its taxable year to the extent an exception applies and
- The aggregate fair market value of the stock of the covered corporation issued or provided by the covered corporation during its taxable year under the netting rule.
One of the six exceptions provided by IRC §4501 includes the de minimis exception. A covered corporation is not subject to the excise tax if, during that taxable year, the aggregate fair market value of the covered corporation’s repurchases of its stock does not exceed $1,000,000. The de minimis test is determined before applying the netting rule and without regard to any statutory exceptions, including stock repurchased which is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan.
Another exception included in the statutory language is provided to stock repurchased if it is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan. This exception applies to a covered corporation’s contribution to an employer-sponsored retirement plan, whether or not the contribution is the same class of stock that was repurchased or a different class than the class of stock that was repurchased. In addition, a covered corporation may treat stock contributions to an employer-sponsored retirement plan as having been contributed in the prior taxable year if contributed by the filing deadline for the IRS Form 720, Quarterly Federal Excise Tax Return, that is due for the first full quarter after the close of the taxpayer’s taxable year.
The stock repurchase excise tax is applied to the fair market value of any stock repurchases by a covered corporation during the taxable year. However, the amount of these repurchases is reduced by:
- The fair market value of any repurchases excluded by an exception; and
- The fair market value of any issuances of the covered corporation’s stock during its taxable year.
For example, on April 15, 2023, when Corporation X’s common stock is trading at $0.70x per share, Corporation X purchases 50x shares of its common stock for $35x from one of its shareholders. On August 1, 2023, Corporation X issues 20x shares of its common stock to an unrelated party. On that date, the common stock of Corporation X is trading at $0.50x per share. Accordingly, the net increase in Corporation X’s stock repurchase excise tax base for its 2023 taxable year is $25x ($35x repurchase – $10x issuance = $25x).
The netting rule does include arrangements where stock is issued or provided to an employee of a covered corporation as compensation for services performed as an employee. Generally, the stock transferred due to a vested stock award or restricted stock unit is issued and allowed to be included in netting when the covered corporation initiates payment of the stock. However, if the employee makes a valid Section 83(b) election, the stock will be treated as issued or provided to the employee as of the transfer date.
Even if a SPAC has a partial redemption that is treated as a repurchase and subject to the excise tax, to the extent there is an issuance of new shares in the same taxable year to PIPE investors, target shareholders, or employees the excise tax should generally be avoided.
It is anticipated that the IRS will provide that the stock repurchase excise tax must be reported on IRS Form 720, Quarterly Federal Excise Tax Return. The Notice announced that the IRS intends to issue an additional form that taxpayers must attach to Form 720 to properly calculate the excise tax on the purchase of corporate stock.
Authors: Lynn Mucenski-Keck, CPA, MST, Principal and National Lead, Federal Tax Policy | [email protected] and Ryan Bixenman, CPA | [email protected]
For more information on this topic, please contact a member of Withum’s Business Tax Services Team.