Wooden block with the words "excise tax"

Will the 1% Excise Tax on Stock Buybacks Apply to Equity Awards?

September 07, 2022

The Inflation Reduction Act of 2022, which was recently signed into law by President Biden, imposes a 1% excise tax on corporations that repurchase their own stock after December 31, 2022. Companies that use equity to compensate employees often regularly buy back their own stock to offset the dilution created by the plan. In addition, certain transactions under the plan, such as share withholding, could be viewed as a repurchase of stock. In this blog entry, I discuss how the excise tax might apply to these transactions.

Summary of the 1% Excise Tax on Repurchases

It’s still early days in terms of understanding how this law applies to stock compensation. I personally have a lot of questions that I suspect won’t be answered until regulations are issued by the Treasury Dept. Here’s what we know so far:

  • Covered Corporations: The excise tax will generally apply to public companies in the United States.
  • Covered Repurchases: The excise tax applies to any stock repurchased by the corporation in a transaction that is considered a redemption under Section 317(b) of the Internal Revenue Code or any economically similar transaction, as defined by Treasury. Section 317(b) defines a redemption as any stock acquired by a corporation “from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock.” This can include stock repurchased from the public markets and in private transactions.
  • Amount Taxed: The excise tax will apply to the fair market value of the shares a corporation repurchases during the tax year. E.g., if a corporation repurchases $50 million worth of stock, the excise tax is $500,000 ($50 million multiplied by 1%).
  • Netting: A key provision when it comes to equity plans is that only the repurchase value in excess of the value of shares issued during the year is subject to the tax. Thus, any shares issued under a company’s stock plans will reduce the excise tax the company owes. If the company in my prior example issued $10 million of stock during the same tax year, the company’s excise tax is reduced to only $400,000 ($50 million repurchased, less $10 million issued, multiplied by 1%).

Exceptions to the Tax

Some repurchases are excepted from the excise tax:

  • Retirement Plans: Most notably, the legislation includes an exception for repurchased shares that are contributed to an employer-sponsored retirement plan, ESOP, or similar plan. It is unclear, however, that this exception will apply to shares contributed to an equity compensation plan.
  • Under $1 Million: If a corporation’s total repurchases for a tax year do not exceed $1 million, the corporation is exempted from the excise tax.
  • Other Exceptions: There are a few other exceptions for certain types of repurchase transactions, such as repurchases treated as a dividend or in connection with a reorganization.

Repurchases to Offset Plan Dilution

As noted above, it is common for companies that offer stock compensation to employees to periodically repurchase their own stock to offset the dilution created by the equity program. Once the excise tax goes into effect, the timing of these repurchases could be important so that the value of the repurchased shares closely aligns with the value of the issued shares.

The legislation does not stipulate how fair market value will be determined for either issuances or repurchases, but my assumption is that it will be based on the value of the stock at the time each transaction occurs. If so, when the stock is higher in value on the repurchase date than it was on the issuance date, the issuance will not fully offset the repurchase, causing the company to be subject to the excise tax.

This timing/value issue may make share withholding and net exercise transactions more attractive for companies than transactions in which shares are sold to fund stock plan acquisitions. Where the shares sold will eventually be repurchased by the company to reduce plan dilution, redeeming the shares at the time of issuance (e.g., share withholding) will be a cleaner solution that eliminates any potential excise tax.

Share Withholding Transactions

A significant question is whether share withholding transactions will be covered under the exception for retirement plans, ESOPs, and similar plans. This is by no means a certainty.

If share withholding is not exempt, the good news is that, for RSUs at least, the netting rule should eliminate any excise tax that the company would be subject to. The shares withheld for taxes will always be less than the shares issued upon payout of an RSU. In addition, because both the issuance and the redemption occur at the same time, both shares will have the same per-share value for purposes of the tax.

But if share withholding is not exempt, this means that only the net shares issued will be available to offset against other repurchases the company makes during the calendar year.

Restricted Stock: Another Nail in the Coffin?

If not exempted, application of the excise tax may be problematic in the case of restricted stock. The netting rule applies on a tax-year basis: only issuances during the same tax year are netted against the year’s repurchases. With restricted stock however, the issuance occurs at grant, which is typically in a tax year prior to when the awards vest and shares are withheld for taxes.

This likely means that the shares issued under the award will not be available to offset the shares repurchased under the same award. They will, however, be able to offset shares withheld for taxes under awards that were granted in prior years and are vesting in the current year. But here there may be a mismatch both in amounts and timing.

Given this, the excise tax may cause companies to shift further away from restricted stock toward RSUs. On the other hand, among companies that grant full value awards, less than 20% currently grant restricted stock (data from the 2021 NASPP/Deloitte Equity Incentive Design Survey). There’s not much room for that percentage to drop further. And, for many of those companies, restricted stock may be an immaterial portion of their overall equity grants.

Net Exercises

The implications for net exercises are the same as for RSUs. If stock options are not exempted from the excise tax, the shares issued upon exercise should fully offset any shares repurchased as a result of the net exercise transaction, eliminating any possible excise tax (but only the net shares issued would be available to offset against other repurchases during the year).

Employee Stock Purchase Plans

Where a company repurchases shares on the open market to offset dilution from its ESPP, it may be desirable to time those repurchases to occur as near as possible to the purchases under the plan, to minimize any differences in values. If shares are withheld to cover taxes (e.g., for non-US employees), the treatment should be the same as for share withholding on RSU awards.

More to Come—Stay Tuned!

Looking for more information? Memos by WilmerHale and Sidley provide the most useful summaries I've found so far on the excise tax.

The legislation requires Treasury to issue regulations implementing the excise tax. We will cover the regulations here in the NASPP Blog once they are issued.

  • Barbara Baksa
    By Barbara Baksa

    Executive Director