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The IRS has finalized regulations for the 1% excise tax on corporate stock repurchases under Section 4501, removing a heavily criticized provision known as the “funding rule,” which could have triggered the tax when a US subsidiary helps its foreign parent finance a buyback. Other changes include the removal of the proposed “no double benefit” item and clarification on the treatment of certain preferred stock. The excise tax, part of the Inflation Reduction Act of 2022, applies to repurchases made after December 31, 2022 and is based on the fair market value of the stock bought back during the tax year.
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Final IRS Rules on 1% Excise Tax on Corporate Stock Repurchase
Final regulations have been released by the IRS for the 1% excise tax on corporate stock repurchases as per Section 4501. As part of the final rules (T.D. 10037), the contentious “funding rule” has been eliminated, a move that has been hailed by many who had criticized it for being unclear and potentially burdensome.
Significance of the “Funding Rule”
The “funding rule” had been under much scrutiny for its potential to trigger the tax when a U.S. subsidiary assists its foreign parent in financing a buyback. Its critics argued that it was vague and could have affected routine transactions, thus increasing the cost of compliance and heightening uncertainty.
Other Changes in the Regulations
Further to the removal of the “funding rule,” the regulations have also been tightened in other areas. They have discarded a proposed “no double benefit” provision that could have ignored certain reorganization and distribution transactions. They have also provided clarity on the treatment of certain types of preferred stock, such as excluding “plain vanilla” stock outlined in Section 1504(a)(4) from the definition of stocks that are subject to the tax.
The Inflation Reduction Act and Excise Tax
The Inflation Reduction Act of 2022 (P.L. 117-169) introduced a 1% excise tax on stock repurchases by publicly traded corporations through Section 4501. The finalized regulations aim to clarify the fair market value (FMV) of a corporation’s stock repurchased in a tax year. The proposed regulations were issued by the IRS in April 2024 and were finalized in July of the same year with rules on procedure and administration for reporting and paying the excise tax.
Application of the Excise Tax
The excise tax is applicable to repurchases made after December 31, 2022, and is calculated based on the FMV of stock bought back during the tax year. The effective date of the final regulations was November 24.
Impact on Mergers and Acquisitions
The IRS has also decided to limit the excise tax’s application to mergers and acquisitions. This change excludes “take-private transactions” and leveraged buyouts and liquidations under Sections 331 and 332.
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