Stock buybacks are a common corporate strategy to boost stock prices and increase shareholder value. A significant amount of buybacks take place in the United States, where companies have historically been able to use their own money or borrow funds at low-interest rates. In 2021, S&P 500 companies repurchased a record $882 billion of their stock. Goldman Sachs analysts predict that buybacks will break another record this year, exceeding $1 trillion.
The U.S. federal government has recently taken steps to curb the use of stock buybacks as a way for corporations to avoid paying taxes on their profits. Starting in 2023, the Inflation Reduction Act provision imposes a 1% excise tax on the market value of net business shares repurchased. This proposition calls for a three-year moratorium on business leaders selling their shares following a repurchase. The tax is in addition to any other applicable taxes, including income taxes on the repurchased shares. The excise tax does not apply if:
- The repurchase is done pursuant to a tender offer or exchange offer that complies with applicable securities laws and regulations; or
- The company’s shares are publicly traded on an established securities market (including an over-the-counter market), and the repurchase occurs within two years after an initial public offering of those shares.
What is an excise tax on stock buybacks?
A stock buyback is the purchase of a company’s own stock by its management. The purpose of this type of transaction is to reduce the number of shares available to trade, thus increasing their value. This action is considered beneficial because it can increase the value of a company’s shares and increase earnings per share (EPS). The Inflation Reduction Act was enacted to reduce the federal deficit by raising revenue from corporations. The Act imposed a 1% excise tax on stock buybacks.
A stock buyback can be beneficial for two reasons:
– It reduces supply, which increases demand and prices.
– It reduces the number of outstanding shares, which gives each shareholder more voting power and helps keep share prices higher than they would otherwise be.
1% tax on stock buybacks may affect investors
Buybacks is a more comprehensive way to divide profits than dividends. Because market reactions to dividend cutbacks are unfavorable, managers are cautious about increasing dividends unless the new payment rate can be maintained. Buybacks can increase the share values. This allows corporate insiders to utilize them for their benefit. A price increase is driven by the demand for repurchase and fewer remaining shares raise the value per share.
The new tax legislation that was signed into law by President Biden has a provision that will impact how companies use their profits. The 1% excise tax on corporate stock buybacks means they may be less likely to buy back shares, thus reducing their supply and increasing the demand for them, which would be good news for shareholders. However, this reduced supply could also mean that share prices go up, which would make it more expensive for a company to raise money through an initial public offering (IPO). If they can’t raise money through an IPO and have to rely on debt instead, then it may not be worth issuing new shares at all because of the additional cost of interest payments. This could result in increased pressure on companies who choose not to issue dividends or do stock buybacks as part of their capital allocation strategy due to these high costs associated with borrowing funds compared with those related to equity financing such as IPOs or stock repurchase programs
Companies buy back their stock to increase the value of their shares to raise earnings per share (EPS). If a company buys back its shares and decreases the number of outstanding shares, it can boost its EPS. This makes sense since EPS is calculated by dividing net income by the number of shares outstanding. If a company can reduce its share count by buying back some or all of its outstanding shares, it will automatically see an increase in EPS without any other real changes in performance metrics such as revenue or profit margins. Typically this tactic works well when there’s investor pressure on management to improve results quickly, for example, if there’s been negative news about a company and investors want better numbers right away so they can sell at higher prices later on down the road.
The Inflation Reduction Act
The Inflation Reduction Act is a bill that would impose a 1 percent tax on repurchases of the corporate stock. The tax would apply to any publicly traded company that repurchases its stock for cash and the amount of the buyback must be greater than $20 million. Repurchase programs are common among many companies, often as part of their compensation packages and incentive plans for executives. They’re also used by private businesses seeking to raise capital or meet regulatory requirements.
The goal of this legislation is not only to discourage excessive executive pay but also to protect workers’ retirement security by ensuring there are adequate savings in 401(k) accounts supported by companies instead of being spent on buybacks. Under the Biden-Harris Administration, the Inflation Reduction Act also aims to expand economic opportunities to small businesses as well as boost U.S. supply chains across technologies like solar, wind, carbon capture, and clean hydrogen.
A 1% excise tax on repurchases of corporate stock would be a marked change in U.S. tax policy and could have major ramifications for the economy and capital markets. This 1% tax would be paid by corporations, investors who sell their shares, companies that buy back shares, and shareholders who sell their shares.
Special Purpose Acquisition Companies (SPACs) would be affected by the 1% tax on stock buybacks. The 1% excise tax on corporate stock buybacks would apply to all SPACs as well, so that means any SPAC that buys back shares and then distributes them to investors may have to pay a 1% excise tax on those distributions.
The proposed 1% excise tax on stock buybacks may be a bad idea, but it is not without precedent. In the past, lawmakers have levied taxes on capital gains to discourage speculation and raise revenue for government projects. However, these measures have often been repealed as quickly as they were enacted and sometimes before even being implemented. The current proposal would add another layer of complexity to an already complex system of corporate taxation.