Tackling the 1% Stock Tax: Future-Proofing Your Corporation

As we near the end of 2024 and move into 2025, U.S. corporations must be well-prepared for the complexities of the excise tax on repurchases of corporate stock introduced by the Inflation Reduction Act. Effective since Dec. 31, 2022, and with final regulations coming into play as late as June 2024, publicly traded corporations and their affiliates must understand the intricacies of this tax. The 1% tax on the fair value (FMV) of repurchased stock is no longer a future consideration but a reality requiring strategic planning and meticulous compliance.

Corporations must have robust systems to accurately track repurchases, calculate tax liabilities and maintain comprehensive records for IRS inspection. With procedural regulations and reporting requirements firmly established and more detailed guidance on tax calculations expected imminently, 2025 will be a year when proactive planning and consultation with tax advisors will be critical to mitigating risks and avoiding penalties associated with non-compliance.

Covered Corporation

The term “covered corporation” relates to any domestic corporation's stock traded on an established market as specified by Section 4501(b).

The 1% tax is also imposed on any repurchase done by a “specified affiliate” of the covered corporation. A specified affiliate is an entity in which the covered corporation owns more than 50% of the stock (by vote or value). A specified affiliate also includes partnerships in which the covered corporation owns more than 50% of the capital interests or profits interests directly or indirectly. Sections 4501(c)(2)(B)(i) & 4501(c)(2)(B)(ii).

Lastly, "covered corporation" includes a specified affiliate of an applicable foreign corporation and a specified affiliate of an expatriated entity of a covered surrogate foreign corporation as defined under Section 4501(d)(1)(A) or (d)(2)(A).

Procedure & Administration

The Treasury Department and the IRS published final regulations to provide rules on procedure and administration applicable to the reporting and payment of the stock repurchase excise tax. These generally follow those in the proposed procedural regulations issued on April 12, 2024. Please note that a companion set of regulations discussing the rules for calculating the stock repurchase excise tax in more detail has not yet been finalized.

Covered corporations that make a repurchase under Section 4501 must keep records that would be sufficient to accurately establish the amount of repurchases, adjustments or exceptions required to be shown in any stock repurchase excise tax return. These records must be kept at all times and available for inspection by the IRS.

Final Procedural Regulations

• The proposed regulations required that the stock repurchase excise tax be reported on a Form 720, Quarterly Federal Excise Tax Return, with a Form 7208, Excise Tax on Repurchase of Corporate Stock. The final regulations clarify that Forms 720 and 7208 only apply for years when there is a stock repurchase.
• In general, a stock repurchase excise tax return must be filed by the due date of Form 720 due date, that is, for the first full calendar quarter after the end of the taxable year of the covered corporation. For example, a covered corporation with a taxable year ending on Dec. 31, 2024, that makes a repurchase during 2024 much file its excise tax return by April 30, 2025, the due date for a first-quarter Form 720.
• The final regulations clarify that with respect to a covered corporation or person treated as a covered corporation and a taxable year ending after Dec. 31, 2022, and on or before June 28, 2024, the stock repurchase excise tax return must be filed by the Form 720 due date for the first full calendar quarter after June 28, 2024, which is Oct. 31, 2024. The regulations also indicate that if a filing is required for more than one taxable year after Dec. 31, 2022, and before June 28, 2024, the taxpayer would file a single Form 720 along with two Forms 7208, one for each tax year included, by Oct. 31, 2024.

Section 4501 imposes on each covered corporation an excise tax equal to 1% of the FMV of any corporation's stock that the corporation repurchases during the taxable year. Section 4501(a).  No deductions are allowed for the payment of the stock repurchase excise tax.

Section 4501(f) authorizes the Secretary of the Treasury to prescribe regulations and other guidance as necessary to implement and prevent the avoidance of the excise tax.

Netting Rule

The amount of repurchases by the covered corporation can be reduced by the FMV of any stock issued during the same taxable year. This includes any FMV of any stock issued or provided to the employees of the covered corporation or those of a specified affiliate.

Statutory Exceptions to the Excise Tax

• Repurchases related to a reorganization, within the meaning of Section 368(a), where the shareholder recognizes no gain or loss.
• Repurchases contributed to an employer-sponsor retirement plan, employee stock ownership plan or similar plan.
• The total value of the stock repurchased during the year does not exceed $1 million (de minimis exception).
• Repurchases made by a dealer in securities in the ordinary course of business.
• Repurchases by a regulated investment company (RIC)/real estate investment trust (REIT).
• Repurchases treated as dividends.

Final Observations

The rules dealing with the new excise tax on repurchases of corporate tax can be complex, especially since final regulations discussing the rules for calculating the excise tax have yet to be finalized. U.S.-covered corporations should consult their tax advisors concerning their specific circumstances. Failure to file the returns and pay the excise tax promptly will be subject to interest and penalties. In fact, the Treasury Department and the IRS have added questions related to the excise tax to tax return forms other than Form 720. To learn more, connect with our tax experts.