What you need to know about the new excise tax on stock buybacks

Companies will have to make a small, but new strategic calculation when it comes to returning capital to investors after President Biden signed a new 1% excise tax on stock buybacks as part of the Inflation Reduction Act.

Implicit for some companies in the new tax is the question of whether to continue with stock buybacks and just suck up the expense as an increased cost of doing business, or to avoid the tax by paying out dividends instead.

For most large corporations like Amazon, Nike, and Apple that have committed tens of billions of dollars to stock buybacks, the 1% tax will likely not alter their plans much, said Allen He, research director at FCLTGlobal, a Boston-based capital markets research group.

“Is it going to impact these really large corporations? It might give them a little bit of a pause, but overall, at 1%, probably not a whole lot,” he said. “Chances are they’re going to continue doing it. They’ll pay the 1%...For them, it’s much more about flexibility.”

However, for smaller companies with thinner margins, the tax may alter the decision-making process, he added.

“[For] some of us smaller companies that aren’t as cash rich, will this become more of an effort for them? Will this force them to think twice about things? Yes, absolutely,” He added.

The new tax is small enough that it is unlikely to change much corporate behavior and companies can easily choose to sidestep the levy, according to one tax expert.

“If somebody really wanted to avoid the tax, all you have to do is pay a dividend instead of a buyback, and they’ve addressed the issue. There’s not a lot of planning that you have to worry about,” said Nick Gruidl, partner and M&A leader in RSM’s Washington national tax office.

However, that dividend strategy shifts the tax burden from the company to shareholders who would be on the hook for income tax versus the lower capital-gains tax rate applied to stock buybacks. That’s a question that shareholders and CFOs may need to communicate more on than in the past, according to He.

“While we do have to keep in mind that the 1% tax is a little bit more, do [investors] prefer dividends or buybacks? That’s something that corporates and CFOs have to juggle now a little bit more,”He said.

Either way, whether the new tax is paid by companies or by shareholders, the impact will likely be minimal, according to Gruidl.

“Because at 1%, is it really going to change a company’s position significantly? It could, maybe I’ll be wrong, and we’ll find that it’s really significant,” Gruidl said.

The S&P reported that 422 companies spent $881.7 billion buying stocks back in 2021. The new excise tax is expected to generate $74 billion a year in revenue, according to a report from Senate Democrats.—DA