Frequently Asked Questions About the Stock Buyback Tax Under the Inflation Reduction Act of 2022
Background
The Inflation Reduction Act of 2022 adds a new Internal Revenue Code
section, Section 4501,1 that imposes a 1 percent excise tax on stock repurchases by publicly traded
companies that occur after December 31, 2022. Specifically, under Section 4501, a
covered corporation is subject to a tax equal to 1 percent of (1) the fair market
value of any stock of the corporation that is repurchased by this corporation (or
certain affiliates) during any taxable year, with limited exceptions, less (2) the
fair market value of any stock issued by the covered corporation (or certain
affiliates) during the taxable year (including compensatory stock issuances). The 1
percent excise tax may also be imposed on acquisitions of stock in certain mergers
or acquisitions involving covered corporations.
Because the tax is not based on a measure of income, the excise tax
is not an income tax and, therefore, is not within the scope of ASC 740.2 The accounting for taxes paid in connection with the repurchase of stock is
not specifically addressed in U.S. GAAP. However, AICPA Technical Q&As Section
4110.093 indicates that direct and incremental legal and accounting costs associated
with the acquisition of treasury stock may be added to the cost of the treasury
stock. Therefore, it is acceptable to account for the Section 4501 excise tax
obligation that results from the repurchase of common stock classified within
permanent equity as a cost of the treasury stock transaction. Any reductions in the
excise tax obligation associated with share issuances would also be recognized as
part of the original treasury stock transaction even if the share issuance is a
different type of instrument than the share that was repurchased.
Additional considerations are necessary when the excise tax obligation is related to
redemptions of preferred stock. Such an excise tax obligation would be recognized as
a cost of redeeming the preferred stock. The accounting for redemptions of preferred
stock differs depending on the classification of the preferred stock as permanent
equity, temporary equity, or a liability. An entity would need to use a systematic
and rational allocation approach to account for the effect of share issuances on the
excise tax obligation when the entity has repurchases of both common stock and
preferred stock during a taxable period.
This publication addresses some frequently asked questions related to the Section
4501 excise tax but does not discuss any legal interpretations associated with this
tax. Note that in this publication, it is assumed that any common stock subject to
the excise tax is classified in permanent equity.
Questions and Answers
General
Question 1
Is an entity required to estimate future stock repurchases and stock
issuances in measuring its excise tax obligation during an interim financial
reporting period?
Answer
No. Because the excise tax is imposed annually, the
calculation of the amount owed for a taxable year is only determined at the
end of the annual period for which the tax is payable. For interim periods,
an entity is not required to estimate future stock repurchases and stock
issuances to measure its excise tax obligation. Rather, an entity can
generally record the obligation on an as-incurred basis.4 In other words, the excise tax obligation recognized at the end of a
quarterly financial reporting period is calculated as if the end of the
quarterly period was the end of the annual period for which the excise tax
obligation is payable. Although the excise tax is not within the scope of
ASC 740, this approach is similar to the accounting for items separately
from the determination of the estimated annual effective tax rate (i.e.,
discrete items).
Example
Entity A, a calendar-year entity, repurchases
common stock with a fair value of $100 million on
February 1, 20X2. Entity A also expects to issue $40
million of common stock during the remaining fiscal
year but has not issued any such stock as of March
31, 20X2. For the interim period ended March 31,
20X2, A would record the following journal entry for
the excise tax:
Although A expects to have net repurchases of $60
million in stock during the fiscal year and
therefore expects to be obligated to pay an excise
tax of $600,000 for the year ended December 31,
20X2, for the three months ended March 31, 20X2, A
has only repurchased common stock that has a fair
value of $100 million. Therefore, as of March 31,
20X2, A recognizes the $1 million tax that would be
payable if A only repurchased $100 million of common
stock (i.e., $100 million × 0.01 = $1 million).
Note
that although an entity is not required to recognize
an excise tax obligation in interim periods by using
an approach based on the estimated annual excise tax
payable, such recognition is not precluded provided
that the amount of tax obligation recorded as of any
balance sheet date does not exceed the amount that
would be payable if the balance sheet date was the
end of the taxable year.5 Such an alternative approach may be consistent
with the estimated annual effective tax rate method
that is used to calculate income taxes on an interim
basis under ASC 740. Given the facts above, for the
interim period ended March 31, 20X2, A would record
the following journal entry for the excise tax if it
used this alternative approach:
Question 2
How should an entity account for an excise tax obligation associated with the
repurchase of preferred stock that is classified in permanent equity?
Answer
The excise tax should be included in the charge (credit) to retained earnings
that is recognized for the redemption of the preferred stock in accordance
with ASC 260-10-S99-2. This charge (credit) is accounted for as a dividend
that adjusts the numerator in the calculation of basic earnings per share.
The obligation for the excise tax should be recognized on the repurchase
date. See Section 3.2.2.6 of Deloitte’s Roadmap Earnings per
Share for more information about the redemption of
preferred stock.
Question 3
How should an entity account for an excise tax obligation associated with the
repurchase of preferred stock that is classified in temporary equity?
Answer
If the preferred stock is being remeasured to its redemption
amount under ASC 480-10-S99-3A(13)–(16), the entity should consider the
probability of redeeming the instrument.6 If it is probable that the preferred stock instrument will be
redeemed, it is appropriate to include the future excise tax obligation in
the periodic remeasurement of the instrument to its redemption amount. Any
adjustment to the excise tax obligation on actual redemption of the
preferred stock would be recognized as a charge (credit) to retained
earnings in accordance with ASC 480-10-S99-3A and ASC 260-10-S99-2. See
Chapter 9
of Deloitte’s Roadmap Distinguishing Liabilities From Equity for more
information about applying the SEC’s guidance on temporary equity.
If the preferred stock is not being remeasured to its redemption amount under
ASC 480-10-S99-3A(13)–(16), or it is not probable that the instrument will
be redeemed, the entity should account for the excise tax in the same manner
as it would account for an excise tax on the redemption of preferred stock
that is not classified in temporary equity. (See Question 2.)
Question 4
How should an entity account for an excise tax obligation associated with the
repurchase of liability-classified preferred stock?
Answer
Preferred stock that is a mandatorily redeemable financial instrument under
ASC 480-10-25-4 must be classified as a liability. Because it is certain on
issuance of such an instrument that it will be redeemed, if the redemption
of the instrument gives rise to an excise tax obligation, that obligation
may be considered to have been incurred on the issuance date. However, if
the redemption was to occur during an annual period in which there are stock
issuances, the entity could owe no excise tax as a result of the redemption
of the liability-classified preferred stock instrument. Furthermore, the
amount of any tax owed could change on the basis of the change in the fair
value of the liability-classified preferred stock instrument. For these
reasons, there may be diversity in the accounting for an excise tax
obligation associated with the repurchase of liability-classified preferred
stock.
Approaches that may be applied in practice to account for an excise tax
obligation associated with the redemption of liability-classified preferred
stock may include:
- View A — Recognize the excise tax obligation on the date the instrument is issued, with an offsetting discount on the preferred stock. This discount would be amortized to interest cost over the life of the instrument in accordance with the interest method in ASC 835-30.
- View B — Recognize the excise tax obligation over the life of the instrument in accordance with the interest method in ASC 835-30. This approach differs from View A only with respect to the timing of when the obligation is recognized.
- View C — Recognize the excise tax obligation on the date the instrument is redeemed. The excise tax would be included in the gain or loss on extinguishment of the instrument. The excise tax amount may be affected by stock issuances during the period the instrument is redeemed.
Because the accounting for an excise tax obligation that is incurred on the
redemption of a liability-classified preferred stock instrument is not
specifically addressed in U.S. GAAP, any of the above three approaches may
be acceptable depending on the facts and circumstances.
Question 5
How should an entity account for an excise tax obligation associated with the
repurchase of a share-based payment award?
Answer
If the share-based payment award was classified as an equity
instrument before the repurchase and no additional compensation cost is
recognized from the repurchase, the excise tax would be recognized in equity
as part of the repurchase transaction.7 If, however, additional compensation cost is recognized as a result of
the repurchase, a portion of the excise tax, if any, that is allocable to
the additional compensation cost should be recognized in earnings.
If the share-based payment award was classified as a liability instrument,
the excise tax should be recognized in earnings as part of the
extinguishment of the liability.
Allocating Offsetting Credits for Stock Issuances
Question 6
How should an entity account for reductions in the excise tax obligation that
result from stock issuance transactions?
Answer
An entity should record the reduction in the tax obligation as a decrease to
the “debit” entry that was recognized from the original repurchase
transaction that gave rise to the excise tax obligation. It is not
acceptable to record the reduction in the tax obligation on the basis of the
nature of the stock issuance transaction that gives rise to the credit to
the overall tax obligation. Such an approach could result in net credits to
income as a result of the excise tax, which is not appropriate (see
Example
1).
Note that the accounting for reductions in an excise tax obligation that
arise from stock issuances could be complex. This is especially the case if
an entity has multiple repurchases and issuances during an annual reporting
period. Therefore, an entity is required to use a systematic and rational
allocation approach to account for the effect of share issuances on the
excise tax obligation when an entity has repurchases of common stock,
preferred stock (whether classified in permanent equity, temporary equity,
or as a liability), and share-based payment awards during a taxable
period.
Example 1
Entity B repurchases $1 billion in common stock,
which results in an excise tax obligation of $10
million. This excise tax is recorded in equity as
follows:
Later in the same taxable year, B grants fully vested
common stock to employees that has a fair value of
$100 million, resulting in a $1 million reduction in
the excise tax amount due. The compensation cost for
these shares is expensed as incurred.
Entity B would record the following journal entry
to account for the impact of the stock issuance on
the excise tax amount due:
If B had associated the excise tax reduction from the
stock issuance with the transaction that gave rise
to this decrease, it would have recognized a $1
million credit to compensation expense. Such
recognition would not be acceptable. Rather, the net
excise tax amount due of $9 million should be
recognized as a debit to treasury stock/APIC.
Example 2
Entity C has the following transactions that are
subject to the Section 4501 excise tax:
- Repurchase of $2 billion of common stock.
- Repurchase of $1 billion of equity-classified preferred stock.
- Issuance of $500 million of common stock as part of a share-based payment arrangement.
Entity C has determined that a pro rata allocation
of the reduction in the total excise tax arising
from the issuance of common stock would represent a
systematic and rational accounting method.
Therefore, C allocates the $5 million benefit (i.e.,
$500 million × 0.01 = $5 million) from the issuance
of common stock as follows:
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Common Stock
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$3,333,333 ($5 million × [$2
billion ÷ $3 billion])
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Preferred stock
|
$1,666,667 ($5 million × [$1
billion ÷ $3 billion])
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Note that if C originally reported a reduction to
retained earnings of $10,000,000 ($1 billion × 0.01
= $10 million) as a result of the repurchase of the
preferred stock, it would later record a credit to
retained earnings of $1,666,667 in such a way that a
net amount of $8,333,333 would be reflected as a
reduction to income available to common stockholders
in the annual calculation of basic earnings per
share.
Statement of Cash Flows
Question 7
How should an entity classify cash paid for excise taxes in its statement of
cash flows?
Answer
ASC 230 does not specifically address the classification of cash outflows for
payment of the excise tax. Therefore, either of the following two
classifications is acceptable:
- Net cash paid for excise taxes is reported in operating activities. This classification is consistent with ASC 230-10-45-17(c), which indicates that “[c]ash payments to governments for taxes, duties, fines, and other fees or penalties” are cash outflows for operating activities.
- Net cash paid for excise taxes is reported in financing
activities. This classification is consistent with ASC
230-10-45-15(a), which states that cash outflows for financing
activities include:Payments of dividends or other distributions to owners, including outlays to reacquire the entity’s equity instruments. Cash paid to a tax authority by a grantor when withholding shares from a grantee’s award for tax-withholding purposes shall be considered an outlay to reacquire the entity’s equity instruments.
An entity should elect one of the two approaches as an accounting policy and
report the net cash paid for excise taxes in either operating or financing
activities. An entity is not permitted to report amounts in both operating
activities and financing activities.
Note that only actual cash payments for excise taxes will affect an entity’s
statement of cash flows. If an entity has recognized an excise tax payable,
it should report that transaction as a noncash financing activity if it
elects to report cash amounts paid within financing activities.
Contacts
For information about this publication, please
contact:
|
|
Ashley Carpenter
Partner
Deloitte & Touche LLP
+1 203 761 3197
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Footnotes
1
Internal Revenue Code Section 4501, “Repurchase of Corporate
Stock.”
2
For titles of FASB Accounting Standards Codification
(ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB
Accounting Standards Codification.”
3
AICPA Technical Questions and Answers Section 4110.09,
“Costs Incurred to Acquire Treasury Stock.”
4
See Questions 3 and 4 for the
accounting for certain preferred stock instruments.
5
However, because of the
complexities of this approach, we would not expect
it to be widely used in practice.
6
Note that this assessment differs from the
requirement in ASC 480-10-S99-3A to assess whether it is probable
that the preferred stock instrument will become redeemable.
7
If the instrument is preferred stock, see Questions 2
and 3.