An Excise Tax on Stock Repurchases and Tax Advantages of Buybacks over Dividends

An Excise Tax on Stock Repurchases and Tax Advantages of Buybacks over Dividends

Updated August 10, 2022
An Excise Tax on Stock Repurchases and Tax Advantages of
Buybacks over Dividends
The Build Back Better Act (H.R. 5376), as reported by the
organizations) will be indifferent to the tax treatment.
Committee on the Budget, includes a provision to impose a
Taxpayers who have a low basis (e.g., because they have
1% excise tax on stock repurchases by publicly traded
held the stock for a long time or because the stock has
corporations. Stock repurchases are another way to
appreciated significantly) will have a small preference for a
distribute income to shareholders and, compared to
repurchase because most of the sale price will be taxable.
dividends, have favorable tax treatment. This provision is
Taxpayers who have a high basis (e.g., if they recently
included in the version of the bill, now called the Inflation
bought the stock) would prefer a share repurchase because
Reduction Act of 2022, that was passed by the Senate on
little of the sales price would be taxable. In addition to this
August 7, 2022.
tax differential, the firm’s purchase of corporation stock can
allow stockholders a choice about how or whether to
What Is a Stock Repurchase?
receive distributions.
A stock repurchase or buy-back occurs when a firm buys its
own shares. This repurchase can be made by a tender offer
Explanation of Excise Tax Provision in
to shareholders, who can then indicate how many shares
the Build Back Better Act
they wish to sell and at what price, or, more commonly,
A provision in H.R. 5376 would impose a 1% excise tax on
shares can be purchased on the open market.
the repurchase of stock by a publicly traded corporation.
The amount subject to tax would be reduced by any new
Stock repurchases have been increasing compared to
issues to the public or stock issued to employees. The tax
dividends. (See CRS Legal Sidebar LSB10266, Stock
would not apply if repurchases were less than $1 million or
Buybacks: Background and Reform Proposals, by Jay B.
if contributed to an employee pension plan, an employee
Sykes.) Historically, dividends were the major form of
stock ownership plan, or other similar plans.
distributing income and share repurchases were rare.
Repurchases began to be more common in the mid-1990s,
The tax would not apply if repurchases were treated as a
and by the early 2000s, dividends and repurchases were
dividend. It would not apply to repurchases by regulated
similar in magnitude. By 2004, annual share repurchases
investment companies (RICs) or real estate investment
had typically begun to exceed dividends. Repurchases
trusts (REITs). It also would not apply to purchases by a
almost doubled in 2018 to more than $1 trillion, following
dealer in securities in the ordinary course of business.
the corporate tax cuts in the Tax Cuts and Jobs Act (P.L.
115-94), and remained high in 2019, although they fell in
The excise tax would apply to purchases of corporation
2020. News articles indicate that almost $900 billion of
stock by a subsidiary of the corporation (i.e., a corporation
repurchases have already occurred in 2021.
or partnership that is more than 50% owned by the parent
corporation). The tax would also apply to purchases by a
Concerns about stock repurchases have led to both nontax
U.S. subsidiary of a foreign-parented firm. It would apply
(such as disallowing stock repurchases on the open market)
to newly inverted (after September 20, 2021) or surrogate
and tax proposals. Tax approaches have included proposals
firms (i.e., firms that merged to create a foreign parent with
to allocate share repurchases to shareholders and tax them
the former U.S. shareholders owning more than 60% of
as dividends or to impose excise taxes. Senator Brown has
shares). The tax will apply to repurchases after December
introduced legislation (S. 2758) to impose a 2% excise tax
31, 2022.
on stock repurchases.
In general, excise taxes can be deducted to determine
Why Are Stock Repurchases Tax
profits subject to the corporate tax, so that the tax is reduced
Favored?
by the corporate tax rate (21%). That is, for a profitable
A dividend is subject to tax, although at a lower rate than
corporation each dollar of excise tax reduces profits taxes
ordinary income (a top rate of 20% compared to a top rate
by 21 cents. The language specifies that this tax would not
of 37% on ordinary income). Capital gains are also subject
be deductible, so there would be no corporate profits tax
to the same tax rate, although the tax applies only to the
offset.
sales price minus the basis (the amount originally paid for
the stock). Therefore, a shareholder pays a larger amount of
Non-Tax Issues
tax on a dividend distribution than on a sale of the share.
Whereas one factor favoring stock repurchases over
dividends is the tax treatment, other concerns have been
Different types of shareholders have different preferences
raised regarding stock repurchases that may be the
for repurchases compared to dividends. Stockholders who
motivation for discouraging these repurchases through an
are tax exempt (such as pension plans and nonprofit
excise tax.
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An Excise Tax on Stock Repurchases and Tax Advantages of Buybacks over Dividends
Firms normally return earnings to shareholders,
Proposals, by Jay B. Sykes.) Still others have expressed
traditionally through dividends. Repurchases serve the same
concerns about leveraged buybacks that may increase debt
purposes. An increase in distributions may occur when the
too much or that buybacks displace investments in capital
firm does not have desirable investment projects. Both
and research and development that are essential for the
dividends and stock repurchases can also signal that the
firm’s long-term health. (See CRS In Focus IF11393, Stock
firm is doing well.
Buybacks: Concerns over Debt-Financing and Long-Term
Investing, by Gary Shorter.)
If all parties have full information, a distribution should
reduce the value of the firm. For dividends, the shares
Revenue Effects
remain constant and the price per share falls. For
The Joint Committee on Taxation (JCT) estimated a gain of
repurchases, the price per share should remain constant
$124 billion over 10 years in the original bill. JCT estimates
while the overall number of shares fall.
a $74 billion gain under the current version. This smaller
gain may reflect the later effective date given large
In practice, other forces may affect per share prices.
repurchases in 2022 and the possibility that companies will
Evidence suggests that share repurchases cause stock prices
repurchase shares prior to the effective date. A 1% tax is
to rise. This rise may simply reflect the increase in demand
relatively small compared to the top tax rate on dividends
from the repurchase if supply does not keep pace at the
and capital gains of 23.8% (20% plus the 3.8% net
going price. This rise in price has been an issue of concern.
investment income tax). However, it would also apply to
For example, some research has suggested that executives
repurchases by tax-exempt investors who hold about half of
use stock repurchases to push the price of the stock up and
corporate shares of U.S. firms and by foreign investors who
generate gains for sales of these executives’ stock. At the
pay no capital gains tax and typically low dividend taxes
same time, much of the executives’ stock is in options that
due to treaties. Foreign investors hold about a quarter of
cannot be traded. (See CRS In Focus IF11506, Stock
shares.
Buybacks and Company Executives’ Profits, by Gary
Shorter for a discussion.) Others argue that stock buybacks

help to concentrate stock among corporate insiders by
buying back shares on the open market from the public and
Jane G. Gravelle, Senior Specialist in Economic Policy
that these corporate insiders initiate buybacks knowing that
the firm’s shares are undervalued. (See CRS Legal Sidebar
IF11960
LSB10266, Stock Buybacks: Background and Reform

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An Excise Tax on Stock Repurchases and Tax Advantages of Buybacks over Dividends

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https://crsreports.congress.gov | IF11960 · VERSION 5 · UPDATED