Part IV

Excise Tax on Repurchase of Corporate Stock

REG-115710-22

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations that would provide guidance regarding the application of the new excise tax on repurchases of corporate stock made after December 31, 2022. The proposed regulations would affect certain publicly traded corporations that repurchase their stock or whose stock is acquired by certain specified affiliates. Another notice of proposed rulemaking (REG-118499-23) on this topic is published in the Proposed Rules section of this issue of the Federal Register to propose rules on procedure and administration applicable to this new excise tax.

DATES: Written or electronic comments and requests for a public hearing must be received by June 11, 2024 .

ADDRESSES: Commenters are strongly encouraged to submit public comments electronically. Submit electronic submissions via the Federal eRulemaking Portal at https://www.regulations.gov (indicate IRS and REG-115710-22) by following the online instructions for submitting comments. Requests for a public hearing must be submitted as prescribed in the “ Com- ments and Requests for a Public Hear- ing ” section. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The Department of the Treasury (Treasury Department) and the IRS will publish for public availability any comment submitted electronically or on paper to its public docket.

Send paper submissions to : CC:PA:01:PR (REG-115710-22), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT: Concerning proposed §§58.4501-1 through 58.4501-6, Samuel G. Trammell at (202) 317-6975; concerning proposed §58.4501-7, Brittany N. Dobi at (202) 317-5469; concerning proposed §1.1275-6(f)(12)(iii), Jonathan A. LaPlante at (202) 317-3900; concerning submissions of comments and requests for a public hearing, Vivian Hayes at (202) 317-6901 (not toll-free numbers) or by email at publichearings@irs.gov (preferred).

SUPPLEMENTARY INFORMATION:

Background

This notice of proposed rulemaking proposes regulations under section 4501 of the Internal Revenue Code (Code) that would implement the new excise tax on repurchases of corporate stock (stock repurchase excise tax) imposed by section 4501 for repurchases made after December 31, 2022. As proposed in this notice of proposed rulemaking, the regulations are proposed to be added as proposed subpart A of new 26 CFR part 58 (Stock Repurchase Excise Tax Regulations), which is proposed to be added to subchapter D of 26 CFR chapter I (Miscellaneous Excise Taxes). This notice of proposed rulemaking also proposes to amend regulations under section 1275 of the Code in 26 CFR part 1 (Income Tax Regulations) to implement the provisions of section 4501. Another notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register relating to the stock repurchase excise tax proposes rules on procedure and administration applicable to the reporting and payment of the stock repurchase excise tax that would be added as proposed subpart B of 26 CFR part 58.

I. Overview of Section 4501

A. In general

Section 4501 was added to a new chapter 37 of the Code by the enactment of

section 10201 of Public Law 117-169, 136 Stat. 1818 (August 16, 2022), commonly referred to as the Inflation Reduction Act of 2022 (IRA). Section 4501 imposes the stock repurchase excise tax on each covered corporation for repurchases made after December 31, 2022. The stock repurchase excise tax is equal to one percent of the fair market value of any stock of the corporation that is repurchased by the corporation during the taxable year. Section 4501(a). For purposes of the stock repurchase excise tax, the term “covered corporation” means any domestic corporation the stock of which is traded on an established securities market (within the meaning of section 7704(b)(1) of the Code). Section 4501(b).

Section 4501(c)(1) provides that repurchases of covered corporation stock to which the stock repurchase excise tax may apply include the following two types of transactions. First, the term “repurchase” means a redemption within the meaning of section 317(b) of the Code with regard to the stock of a covered corporation (section 317(b) redemption). Section 4501(c) (1)(A). Second, the term “repurchase” also means any transaction determined by the Secretary of the Treasury or her delegate (Secretary) to be economically similar to a section 317(b) redemption (economically similar transaction). Section 4501(c)(1)(B).

B. Specified affiliates

For purposes of the stock repurchase excise tax, section 4501(c)(2)(A) provides a special rule that treats the acquisition of stock of a covered corporation by a specified affiliate of the covered corporation, from a person who is not the covered corporation or a specified affiliate of the covered corporation, as a repurchase of the stock of the covered corporation by the covered corporation. For this purpose, the term “specified affiliate” means, with regard to any corporation, (i) any corporation more than 50 percent of the stock of which is owned (by vote or by value), directly or indirectly, by the corporation, and (ii) any partnership more than 50 percent of the capital interests or profits inter

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ests of which is held, directly or indirectly, by the corporation. Section 4501(c)(2)(B).

C. Adjustment to amount taken into account under section 4501(a)

The stock repurchase excise tax is applied to the fair market value of any stock of the covered corporation repurchased by the covered corporation during its taxable year. However, the amount of these repurchases is reduced by the fair market value of any issuances of the covered corporation’s stock during the covered corporation’s taxable year (netting rule).

Specifically, the netting rule provides that the amount taken into account under section 4501(a) with respect to any stock repurchased by a covered corporation is reduced by the fair market value of any stock issued by the covered corporation during the taxable year, including the fair market value of any stock issued or provided to employees of the covered corporation or employees of a specified affiliate of the covered corporation during the taxable year (whether or not the stock is issued or provided in response to the exercise of an option to purchase the stock). Section 4501(c)(3).

D. Special rules for certain acquisitions and repurchases of stock of certain foreign corporations

Section 4501(d) provides special rules for the imposition of the stock repurchase excise tax on acquisitions of stock of applicable foreign corporations and covered surrogate foreign corporations. For purposes of section 4501(d), the term “applicable foreign corporation” means any foreign corporation the stock of which is traded on an established securities market. Section 4501(d)(3)(A). The term “covered surrogate foreign corporation” means any surrogate foreign corporation (as determined under section 7874(a)(2)(B) of the Code by substituting “September 20, 2021” for “March 4, 2003” each place it appears) the stock of which is traded on an established securities market, but only with respect to taxable years that include any portion of the applicable period with respect to that corporation under section 7874(d)(1). Section 4501(d)(3)(B).

Section 4501(d)(1) applies in the case of an acquisition of stock of an applicable foreign corporation by a specified affiliate of the corporation (other than a foreign corporation or a foreign partnership (unless the partnership has a domestic entity as a direct or indirect partner)) from a person that is not the applicable foreign corporation or a specified affiliate of the applicable foreign corporation. If section 4501(d)(1) applies, then for purposes of determining the stock repurchase excise tax: (i) the specified affiliate is treated as a covered corporation with respect to the acquisition; (ii) the acquisition is treated as a repurchase of stock of a covered corporation by the covered corporation; and (iii) the adjustment under section 4501(c)(3) (that is, the netting rule) is determined only with respect to stock issued or provided by the specified affiliate to employees of the specified affiliate.

Section 4501(d)(2) applies in the case of either a repurchase of stock of a covered surrogate foreign corporation by the covered surrogate foreign corporation, or an acquisition of stock of a covered surrogate foreign corporation by a specified affiliate of such corporation. If section 4501(d)(2) applies, then for purposes of determining the stock repurchase excise tax: (i) the expatriated entity (within the meaning of section 7874(a)(2)(A)) with respect to the covered surrogate foreign corporation is treated as a covered corporation with respect to the repurchase or acquisition; (ii) the repurchase or acquisition is treated as a repurchase of stock of a covered corporation by the covered corporation; and (iii) the adjustment under section 4501(c)(3) is determined only with respect to stock issued or provided by the expatriated entity to employees of the expatriated entity.

E. Statutory exceptions to the application of section 4501(a)

Section 4501(e) lists transactions that are statutorily excepted, in whole or in part, from the application of section 4501(a), each referred to as a “statutory exception” in this preamble. As a result of the statutory exceptions, section 4501(a) does not apply to a repurchase of a covered corporation’s stock:

(1) To the extent that the repurchase is part of a reorganization (within the meaning of section 368(a) of the Code) and no gain or loss is recognized on the repurchase by the shareholder under chapter 1 of the Code (chapter

1. by reason of the reorganization (section 4501(e)(1));

(2) In any case in which the stock repurchased is, or an amount of stock equal to the value of the stock repurchased is, contributed to an employer-sponsored retirement plan, employee stock ownership plan (ESOP), or similar plan (section 4501(e)(2)); (3) In any case in which the total value of the stock repurchased during the taxable year does not exceed $1,000,000 (section 4501(e)(3));

(4) Under regulations prescribed by the Secretary, in cases in which the repurchase is by a dealer in securities in the ordinary course of business (section 4501(e)(4));

(5) By a regulated investment company (RIC), as defined in section 851 of the Code, or by a real estate investment trust (REIT), as defined in section 856(a) of the Code (section 4501(e)(5)); or

(6) To the extent that the repurchase is treated as a dividend for purposes of the Code (section 4501(e)(6)).

F. Regulations and other guidance

Under section 4501(f), the Secretary is authorized to prescribe such regulations and other guidance as are necessary or appropriate to carry out, and to prevent the avoidance of, the purposes of the stock repurchase excise tax. Regulations or other guidance described in section 4501(f) may include guidance: (i) to prevent the abuse of the statutory exceptions; (ii) to address special classes of stock and preferred stock; and (iii) for the application of the special rules for acquisitions of stock of certain foreign corporations under section 4501(d).

G. Applicability of stock repurchase excise tax provisions

Except to the extent that a statutory exception applies, the stock repurchase excise tax applies to repurchases after December 31, 2022, subject to the netting rule. See section 10201(d) of the IRA.

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In contrast to the December 31, 2022, effective date expressly provided by section 10201(d) of the IRA with regard to repurchases, the netting rule expressly takes into account any issuances by a covered corporation during the entirety of its taxable year. See generally section 4501(c)(3). Specifically, under the netting rule, the amount taken into account under section 4501(a) with respect to any repurchases is “reduced by the fair market value of any stock issued by the covered corporation during the tax- able year .” Section 4501(c)(3) ( emphasis added ). Therefore, a covered corporation with a taxable year that both began before January 1, 2023, and ended after December 31, 2022, may apply the netting rule to reduce the fair market value of the covered corporation’s repurchases of stock during the portion of that taxable year beginning on January 1, 2023, by the fair market value of all issuances of its stock during the entirety of that taxable year.

H. No deduction for payment of stock repurchase excise tax

No deduction is allowed for the payment of the stock repurchase excise tax. See section 275(a)(6) of the Code (as amended by section 10201(b) of the IRA to add a reference to chapter 37, which contains section 4501).

II. Notice 2023-2

On January 17, 2023, the Treasury Department and the IRS published Notice 2023-2, 2023-3 I.R.B. 374, to provide initial guidance regarding the application of the stock repurchase excise tax. Specifically, the Treasury Department and the IRS published Notice 2023-2 to facilitate administration of the stock repurchase excise tax by describing rules expected to be provided in forthcoming proposed regulations for determining the amount of stock repurchase excise tax owed, along with anticipated rules for reporting and paying any liability for the tax.

Under those rules, the amount of stock repurchase excise tax imposed on a covered corporation equals the product obtained by multiplying one percent by the stock repurchase excise tax base of the covered corporation. The “stock repurchase excise tax base” is the amount (not

less than zero) obtained by: (i) determining the aggregate fair market value of all repurchases of the covered corporation’s stock by the covered corporation during its taxable year; (ii) reducing that amount by the fair market value of stock of the covered corporation repurchased during its taxable year to the extent any statutory exceptions apply; and then (iii) further reducing that amount by the aggregate fair market value of stock of the covered corporation issued or provided by the covered corporation during its taxable year under the netting rule.

The Treasury Department and the IRS have received feedback on the stock repurchase excise tax, including in response to Notice 2023-2. Based on the feedback received, and based on further consideration of section 4501 and Notice 2023-2, the Treasury Department and the IRS are proposing these regulations under section 4501 to be added as a new part 58 under the Miscellaneous Excise Taxes, as well as adding new §1.1275-6(f)(12)(iii) to 26 CFR part 1.

The issues related to section 4501 and Notice 2023-2 with respect to which stakeholders have provided feedback, as well as issues that the Treasury Department and the IRS have considered after the publication of Notice 2023-2, are discussed in the following Explanation of Provisions.

Explanation of Provisions

Subpart A of new part 58 would provide operative rules under section 4501. Proposed §58.4501-1 would provide an overview of the stock repurchase excise tax, generally applicable definitions, the scope of the regulations implementing that tax, and certain operating rules applicable to those regulations. Proposed §58.4501-2 would provide general rules regarding the application and computation of the stock repurchase excise tax and proposed §58.4501-7 would provide rules specifically relating to the application of section 4501(d). Except as provided in proposed §58.4501-7, proposed §58.4501-3 would provide rules regarding the application of the exceptions in section 4501(e) (other than the de minimis exception described in section 4501(e)(3) and to which proposed §58.4501-2(b)(2) applies), and proposed

§58.4501-4 would provide rules regarding the application of section 4501(c) (3). Proposed §58.4501-5 would provide examples that illustrate the application of section 4501, other than the provisions of proposed §58.4501-7 (which are illustrated by examples in §58.4501-7(p) and (q)), and proposed §58.4501-6 would provide applicability dates (other than for the rules in §58.4501-7).

I. Statutory Effective Date; Transition Relief

A. Repurchases by a fiscal-year taxpayer prior to the statutory effective date

A covered corporation is not subject to the stock repurchase excise tax with regard to a taxable year if, during that taxable year, the aggregate fair market value of the covered corporation’s repurchases of its stock does not exceed $1,000,000 (de minimis exception). See section 4501(e) (3); see also section 3.03(2)(a) of Notice 2023‑2. One stakeholder requested that the proposed regulations make clear that repurchases of stock by a fiscal-year taxpayer prior to the January 1, 2023, effective date of section 4501 are not taken into account for purposes of applying the de minimis exception. According to the stakeholder, the plain language of the statute requires that repurchases by a fiscal-year taxpayer prior to January 1, 2023, not be taken into account for any purpose under section 4501, including for purposes of applying the de minimis exception.

The Treasury Department and the IRS have interpreted section 4501 in the same manner. The rule described in section 3.03(3)(b) of Notice 2023-2 provides that repurchases by a covered corporation before January 1, 2023, are not included in the covered corporation’s stock repurchase excise tax base. The proposed regulations would clarify that repurchases before January 1, 2023, are not taken into account for purposes of applying the de minimis exception. See proposed §58.4501‑2(c)(3).

B. Issuances by a fiscal-year taxpayer prior to the effective date

One stakeholder recommended that stock issued by a fiscal-year taxpayer

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prior to January 1, 2023, should not be taken into account for purposes of the netting rule, because such an approach would create a mismatch between the treatment of issuances for purposes of the netting rule and the treatment of repurchases for purposes of the de minimis exception. See part I.A of this Explanation of Provisions. Another stakeholder recommended that fiscal-year taxpayers be permitted to use only net issuances (that is, issuances net of repurchases) from the portion of their taxable year prior to January 1, 2023, because, according to the stakeholder, taxpayers arguably should not be permitted to offset gross issuances during the portion of a fiscal year before January 1, 2023, against repurchases during the portion of a fiscal year beginning on January 1, 2023.

The Treasury Department and the IRS disagree with the stakeholders’ recommendations. Section 4501(c)(3) expressly provides that the amount taken into account under section 4501(a) with respect to any stock repurchased by a covered corporation is reduced by the fair market value of any stock issued by the covered corporation “during the taxable year.” Moreover, although section 10201(d) of the IRA expressly provides that the stock repurchase excise tax applies to repurchases after December 31, 2022, it does not contain similar language for issuances . Therefore, the Treasury Department and the IRS are of the view that, in the case of a covered corporation that has a taxable year that both begins before January 1, 2023, and ends after December 31, 2022, that covered corporation may apply the netting rule to reduce the fair market value of the covered corporation’s repurchases during that taxable year by the fair market value of all issuances of its stock during the entirety of that taxable year. See proposed §58.45014(b)(3). Thus, the proposed regulations would not adopt these recommendations.

C. Contributions by fiscal-year taxpayer to employer-sponsored retirement plan prior to effective date

A stakeholder also recommended that stock contributed by a fiscal-year taxpayer to an employer-sponsored retirement plan prior to the January 1, 2023, effective date of section 4501, should not be taken into account for purposes of the statutory

exception in section 4501(e)(2) because, according to the stakeholder, such an approach would create a mismatch between this exception and the de minimis exception. However, as discussed in part I.B of this Explanation of Provisions, the effective date in section 10201(d) of the IRA expressly applies to repurchases (and not to issuances or contributions). Therefore, the Treasury Department and the IRS are of the view that contributions to an employer-sponsored retirement plan during the 2022 portion of a taxable year beginning before January 1, 2023, and ending after December 31, 2022, should be taken into account for purposes of section 4501(e)(2). See proposed §58.45013(d)(5).

D. Trade date or settlement date

A stakeholder asked whether the date of repurchase of stock occurs on (i) the trade date for the sale or purchase of that stock (that is, the date a broker executes the trade), or (ii) the settlement date with regard to that stock (that is, the date the shares are delivered). The stakeholder asked this question for purposes of determining whether a repurchase occurs after the effective date of section 4501. The stakeholder requested that the proposed regulations clarify that the trade date for the sale or purchase of that stock constitutes the date of repurchase.

The proposed regulations would clarify that the date of repurchase for a regular-way sale of stock on an established securities market (that is, a transaction in which a trade order is placed on the trade date, and settlement of the transaction, including payment and delivery of the stock, occurs a standardized number of days after the trade date) is the trade date. See proposed §58.4501-2(g)(2). For rules regarding the date of repurchase generally, see part III.B.1 of this Explanation of Provisions.

E. Transition relief for certain transactions entered into prior to enactment date

Several stakeholders requested transition relief (that is, an exemption from the stock repurchase excise tax) for certain repurchases that occur after the January

1, 2023, effective date of section 4501, pursuant to a binding commitment entered into before the August 16, 2022, enactment date of section 4501. For example, one stakeholder requested an exemption for redemptions of stock issued before the enactment date and redeemed pursuant to the terms of the stock after the effective date, on the grounds that the stock repurchase excise tax did not exist when the terms of that stock were negotiated. Another stakeholder suggested that candidates for transition relief could include: (i) redemptions by, and liquidations of, a special purpose acquisition company (SPAC) formed prior to the enactment date (to the extent the SPAC is contractually obligated to offer redemption rights to its shareholders as agreed prior to the enactment date); (ii) payments in connection with merger and acquisition (M&A) transactions pursuant to a binding commitment entered into prior to the enactment date; (iii) redemptions of non-participating, non-convertible preferred stock, and complete redemptions of tracking stock, issued prior to the enactment date; (iv) repurchases pursuant to accelerated share repurchase agreements if completed pursuant to a binding commitment entered into prior to the enactment date; and (v) liquidating distributions subject to section 331 of the Code pursuant to a plan of liquidation adopted prior to the enactment date.

The plain language of section 10201(d) of the IRA provides that the amendments made by section 10201 of the IRA apply to repurchases of stock after December 31, 2022. That section contains no reference to repurchases that occur pursuant to a binding commitment entered into prior to the enactment date. As a result, the Treasury Department and the IRS are of the view that transition relief would not be appropriate. The proposed regulations accordingly would not adopt the stakeholders’ recommendation.

II. Application of the Stock Repurchase Excise Tax to Various Types of Financial Instruments

A. Definition of “stock”

For purposes of Notice 2023-2, “stock” would be defined as any instrument issued

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by a corporation that is stock or that is treated as stock for Federal tax purposes at the time of issuance, regardless of whether the instrument is traded on an established securities market. See section 3.02(25) of Notice 2023-2.

The proposed regulations generally would maintain this definition of “stock.” See proposed §58.4501-1(b)(29). However, the proposed definition of “stock” would not include “additional tier 1 preferred stock,” which the proposed regulations would define to mean preferred stock that qualifies as additional tier 1 capital (within the meaning of 12 CFR 3.20(c), 217.20(c), or 324.20(c)) and does not qualify as common equity tier 1 capital (within the meaning of 12 CFR 3.20(b), 217.20(b), or 324.20(b)). See proposed §58.4501-1(b)(29)(ii). Therefore, unless the limited-scope exception regarding additional tier 1 preferred stock applies, the stock repurchase excise tax would apply to preferred stock in the same manner as to common stock. Likewise, the stock repurchase excise tax would apply to repurchases of instruments that are not in the legal form of stock but that are treated as stock for Federal tax purposes at the time of issuance. In contrast, the stock repurchase excise tax would not apply to repurchases of instruments treated as debt for Federal tax purposes.

The proposed regulations would include the foregoing definition of “stock” for the following reasons. First, the plain language of section 4501 repeatedly refers to “stock” and does not, for example, refer solely to “common stock.” See, for example, section 4501(a) (imposing an excise tax “equal to 1 percent of the fair market value of any stock of the corporation”); section 4501(b) (defining the term covered corporation to mean “any domestic corporation the stock of which is traded on an established securities market”); section 4501(c)(1)(A) (defining the term repurchase to mean a redemption within the meaning of section 317(b) “with regard to the stock of a covered corporation”). Second, if the stock repurchase excise tax were implemented to be applicable solely to common stock, then taxpayers could avoid the tax simply by repurchasing other classes of stock (or other instruments treated as stock for Federal tax purposes).

Section 4501(f)(2) authorizes the Secretary to issue such regulations and other guidance as are necessary or appropriate to carry out, and to prevent the avoidance of, the purposes of the stock repurchase excise tax, including guidance “to address special classes of stock and preferred stock.” Accordingly, in section 6.01(1) of Notice 2023-2, the Treasury Department and the IRS requested comments on whether there are circumstances under which special rules should be provided for redeemable preferred stock or other special classes of stock or debt (including debt with features that allow the debt to be converted into stock) and, if so, what objectively verifiable criteria should be incorporated into such special rules to provide certainty for taxpayers and the IRS.

1. Straight Preferred Stock; Mandatorily Redeemable Stock

Stakeholders recommended that the stock repurchase excise tax should not apply to redemptions of preferred stock. Although two stakeholders recommended an exception for redemptions of any type of preferred stock, other stakeholders generally recommended an exception only for redemptions of so-called “straight preferred stock” (that is, preferred stock that is limited and preferred as to dividends, does not participate in corporate growth to any significant extent, and is not convertible into another class of stock). See section 1504(a)(4)(B) and (D) of the Code. One stakeholder also argued against providing an exception for redemptions of preferred stock other than straight preferred stock. See part II.A.2 of this Explanation of Provisions.

The stakeholders uniformly contended that, although straight preferred stock is treated as “stock” for Federal tax purposes, repayments of such stock are akin to repaying debt and do not implicate the policy concerns underlying the stock repurchase excise tax. The stakeholders further contended that, if redemptions of straight preferred stock were subject to the stock repurchase excise tax, publicly traded corporations might be incentivized to increase their leverage by issuing debt in lieu of straight preferred stock.

One stakeholder also recommended a rule under which actual or deemed issu

ances of straight preferred stock would not be taken into account for purposes of the netting rule. The stakeholder further recommended that exchanges of straight preferred stock for other stock (that is, for stock to which the stock repurchase excise tax applies) should be treated as economically similar transactions.

Alternatively, stakeholders recommended an exception to the stock repurchase excise tax for the redemption of stock pursuant to a mandatory redemption provision or a unilateral put option of the shareholder. In the stakeholders’ view, this exception would be appropriate because such a redemption would not be within the control of (and would not be susceptible to any timing manipulation by) the issuing corporation.

As described in part II.A of this Explanation of Provisions, the plain language of section 4501 consistently refers to “stock” without providing any exceptions for particular types of stock. In addition, the Treasury Department and the IRS are of the view that Treasury regulations that utilize the broadly applicable term “stock” would facilitate the IRS’s ability to administer and enforce the stock repurchase excise tax. Consequently, the Treasury Department and the IRS also are of the view that adoption of the stakeholders’ numerous suggested exceptions would significantly hamper the IRS’s ability to administer and enforce that tax, as well as reduce taxpayer certainty regarding its application. Therefore, except with regard to additional tier 1 preferred stock, the proposed regulations would not incorporate the stakeholders’ suggested exceptions. See proposed §§58.4501-1(b)(29), 58.4501-2(e)(2), and 58.4501-4(b)(1); see also proposed §58.4501-1(b)(29)(ii) and part II.A.3 of this Explanation of Provisions (discussion of additional tier 1 preferred stock).

2. Convertible Preferred Stock and Participating Preferred Stock

One stakeholder recommended that, even if straight preferred stock is excluded from the stock repurchase excise tax, preferred stock that is convertible into the issuer’s common stock at the holder’s option (convertible preferred stock), and preferred stock with certain dividend or

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ration as well as transactions that are “economically similar” to such redemptions. See section 4501(c)(1). Accordingly, the Treasury Department and the IRS are of the view that no special rules are needed for convertible debt. However, for a discussion of the application of the netting rule to an instrument not in the legal form of stock, see part XI.C.9 of this Explanation of Provisions.

5. Tracking Stock

Tracking stock is an instrument that tracks the performance of a division of the parent corporation or a subsidiary (for example, by providing dividend rights that are determined by reference to the earnings of the tracked division or subsidiary). Because tracking stock participates in corporate growth, a stakeholder recommended treating the redemption of less than all shares of a class of tracking stock in the same manner as the redemption of other common stock—that is, as subject to the stock repurchase excise tax.

However, the stakeholder also suggested that an exemption may be warranted for the redemption of an entire class of tracking stock in connection with the disposition of the underlying tracked business, because such a redemption (i) does not accrete to the interests of the corporation’s remaining shareholders in the corporation’s remaining assets, and (ii) may be equivalent to a distribution in partial liquidation. (As discussed in part VI.B of this Explanation of Provisions, the stakeholder recommended treating partial liquidations as generally outside the scope of the stock repurchase excise tax.)

The Treasury Department and the IRS are of the view that the treatment of tracking stock for purposes of the stock repurchase excise tax should follow the general Federal tax treatment of tracking stock. Accordingly, no special guidance regarding the proper treatment of tracking stock is included in these proposed regulations.

B. Characterization of instruments as stock or debt

One stakeholder requested confirmation that the determination of whether an instrument is stock or debt for purposes of the stock repurchase excise tax is made

liquidation participation rights that enable the holder to participate in corporate growth to a significant extent (participating preferred stock), should continue to be subject to the stock repurchase excise tax. In the stakeholder’s view, a redemption of such stock generally is more akin to a redemption of common stock than to a repayment of debt or a redemption of straight preferred stock (for example, there are fewer outstanding shares of stock participating in future corporate growth after such a redemption).

For the reasons stated in part II.A.1 of this Explanation of Provisions, the Treasury Department and the IRS agree with the stakeholder’s recommendation. Accordingly, under the proposed regulations, the repurchase of convertible or participating preferred stock would be subject to the stock repurchase excise tax, and the issuance of such stock would be taken into account for purposes of the netting rule. See proposed §§58.4501-1(b)(29), 58.4501-2(e)(2), and 58.4501-4(b)(1).

3. Additional Tier 1 Preferred Stock

Several stakeholders noted that the issuance and redemption of preferred stock is used routinely in certain industries as a way to manage risk. One stakeholder recommended an exception to the stock repurchase excise tax and the netting rule for redemptions or issuances of preferred stock that qualifies as additional tier 1 capital for purposes of regulatory requirements for regulated financial institutions (additional tier 1 preferred stock).

According to the stakeholder, the issuing corporation may not redeem or repurchase additional tier 1 preferred stock without prior approval from regulators. Moreover, if such an instrument is callable by its terms, (i) it may not be called for at least five years; (ii) the issuing corporation must receive prior approval from regulators to exercise the call option; and (iii) the issuing corporation must either replace the instrument with other tier 1 capital or demonstrate to regulators that it will continue to hold capital commensurate with risk.

Based on the feedback received, the Treasury Department and the IRS are of the view that the stock repurchase excise tax regulations should not apply to addi

tional tier 1 preferred stock. See proposed §58.4501-1(b)(29)(ii). Consequently, under the proposed regulations, additional tier 1 preferred stock would not be subject to the stock repurchase excise tax, and the issuance of additional tier 1 preferred stock would not be taken into account for purposes of the netting rule.

4. Convertible Debt

Stakeholders have requested confirmation that redemptions of convertible debt instruments are not subject to the stock repurchase excise tax. One stakeholder contended that such transactions should not be treated as “economically similar” to a section 317(b) redemption because the definition of “redemption” in section 317(b) encompasses only redemptions of stock, and because a redemption of a convertible debt instrument does not reduce the number of a corporation’s outstanding shares. Another stakeholder contended that the determination of whether an instrument constitutes debt or equity should be made at the time of issuance. Therefore, if the convertible debt instrument is characterized as “debt” at the time of issuance, the subsequent redemption or cash settlement of that instrument should not be treated as a repurchase. Likewise, the issuance of a convertible debt instrument by a covered corporation should not be treated as an issuance for purposes of the netting rule.

The Treasury Department and the IRS agree with these stakeholders. Although Notice 2023-2 does not expressly address convertible debt instruments, the Treasury Department and the IRS continue to be of the view that, for purposes of the stock repurchase excise tax, whether an instrument is debt or equity should be determined at the time of issuance under Federal income tax principles, and that this characterization should not be retested while the debt instrument is outstanding. See proposed §58.4501-1(b)(29); see also part II.B of this Explanation of Provisions. Such an approach would better facilitate the IRS’s ability to administer and enforce the stock repurchase excise tax and enable taxpayers to apply the tax with greater certainty. Moreover, the term “repurchase” includes only section 317(b) redemptions with regard to “stock” of a covered corpo

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at the time of issuance under Federal tax principles, and that this characterization is not retested subsequently while the instrument is outstanding. The Treasury Department and the IRS agree with this recommendation, because, as previously stated, such an approach under which an instrument is tested only once would better facilitate the IRS’s ability to administer and enforce the stock repurchase excise tax and enable taxpayers to apply the tax with greater certainty. See proposed §58.4501-1(b)(29).

C. Options and similar financial instruments

1. Overview

As discussed previously, Notice 2023-2 would define “stock” to mean any instrument issued by a corporation that is stock or that is treated as stock for Federal tax purposes at the time of issuance. See section 3.02(25) of Notice 2023-2. This definition of “stock” generally excludes options other than options that are treated as stock for Federal tax purposes at the time of issuance.

To the extent option contracts are not treated as stock at the time of issuance, the acquisition of such contracts is not a repurchase under Notice 2023-2 because such acquisition is neither a section 317(b) redemption nor included in the exclusive list of economically similar transactions in section 3.04(4)(a) of Notice 2023-2. Consequently, under Notice 2023-2, there is a repurchase or an issuance of stock only at the time of exercise of a physically settled option (when a covered corporation repurchases or issues the actual underlying stock). In turn, the amount of such repurchase or issuance is equal to the market price of the stock on the date the stock is repurchased or issued. See sections 3.06(1)(a), 3.06(2), 3.08(2), and 3.08(5) of Notice 2023-2; see also part III of this Explanation of Provisions (discussion of valuation and timing).

Several questions have arisen regarding the application of the stock repurchase excise tax to options and similar financial instruments. In section 6.02(4) of Notice 2023-2, the Treasury Department and the IRS requested comments on: (i) whether any additional rules with regard to finan

cial arrangements, such as options or other similar financial instruments, should be added to prevent avoidance of the stock repurchase excise tax; and (ii) how such additional rules should apply consistently for purposes of determining a covered corporation’s repurchases and issuances.

2. Physical Settlement of Option Contracts

Stakeholders recommended that the fair market value of shares acquired or issued (as appropriate) by a covered corporation upon physical settlement of an option contract should be the fair market value of the shares on the date of exercise, rather than the strike price (that is, the price at which the option can be exercised). For example (Example 1), assume that corporation X issues a call option to individual A that entitles A to buy 100 shares of X stock for $100 ($1.00 per share) from X for a limited time. The terms of the option require physical settlement. On the date the option is issued, X stock is trading at $1.00 per share. On the date the option is exercised, X stock is trading at $1.30 per share. Upon settlement of the option, A pays $100 to X, which issues 100 shares of X stock (worth $130) to A.

Alternatively (Example 2), assume the same facts as in Example 1, except that X issues a put option to A that entitles A to sell 100 shares of X stock for $100 ($1.00 per share) to X, and that X stock is trading at $0.70 per share on the date the option is exercised. To settle the option, X purchases 100 shares of X stock (worth $70) for $100 from A.

As another example (Example 3), assume that A issues a call option to unrelated individual B that entitles B to buy 100 shares of X stock for $100 ($1.00 per share) from A for a limited time. The terms of the option require physical settlement. Subsequently, X purchases the option contract from B. On the date the option is exercised, X stock is trading at $1.30 per share. To settle the option, X pays $100 to A, who delivers 100 shares of X stock (worth $130) to X.

The netting rule requires the stock repurchase excise tax base to be reduced by “the fair market value of any stock issued by the covered corporation during the taxable year.” See section 4501(c)(3). Thus,

according to stakeholders, the amount of the issuance in Example 1 should be $130 (the fair market value of the stock at the time of issuance) even though A pays only $100 to excise the option.

Similarly, the stock repurchase excise tax applies to “the fair market value of any stock of the corporation which is repurchased by such corporation during the taxable year.” See section 4501(a). Consequently, stakeholders suggested that the amount of the repurchase in Example 2 should be $70, and that the $30 premium paid by X represents the amount paid for a property right separate from the stock being repurchased. Cf . Rev. Rul. 70-108, 1970-1 C.B. 78 (holding that the right to purchase additional shares constitutes separate property from the underlying shares). Consistent with this approach, stakeholders also suggested that the amount of the repurchase in Example 3 should be $130 (the fair market value of the stock on the exercise date).

The Treasury Department and the IRS agree with the stakeholders that the amount of the issuance in Example 1 should be $130 (the fair market value of the issued stock on the exercise date) rather than $100 (the strike price paid by A). Similarly, the Treasury Department and the IRS agree that the amount of the repurchase in Example 2 should be $70 rather than $100, and that the amount of the repurchase in Example 3 should be $130 rather than $100.

The foregoing approach, which is consistent with Notice 2023-2, is embedded in the proposed rules regarding the fair market value of repurchased or issued stock. See proposed §§58.4501-2(h) (1) and 58.4501-4(e)(1), respectively. Thus, the Treasury Department and the IRS are of the view that special rules are not needed with respect to the fair market value of stock repurchased or issued upon the physical settlement of an option. However, the proposed regulations would include several examples to illustrate the proposed approach. See proposed §58.4501-5(b)(26) and (28). For special rules for valuing stock issued or provided to an employee or other service provider in connection with the performance of services, see proposed §58.4501-4(e)(5) and part XI.G.7 of this Explanation of Provisions.

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3. Cash Settlement of Option Contracts

As previously discussed in part II.C.2 of this Explanation of Provisions, stakeholders recommended treating the physical settlement of an option as a repurchase or an issuance (as appropriate) based on the fair market value of the stock repurchased or issued on the date of exercise. In contrast, a stakeholder recommended that the cash settlement of a put option issued by a covered corporation should not be treated as a repurchase by the covered corporation, because any excess of the strike price over the fair market value of the underlying stock should be viewed as payment for property that is separate from the underlying stock. Cf . Rev. Rul. 70-108. For example, assume that corporation X issues a put option to individual A that entitles A to sell 100 shares of X stock for $100 ($1.00 per share) to X, and that X stock is trading at $0.70 per share on the date the option is exercised. The terms of the option require net cash settlement; thus, X pays $30 to A to settle the option. The stakeholder recommended not treating the net cash settlement as a repurchase, even though the settlement could be construed as a purchase by X of the 100 X shares from A for $100, immediately followed by an issuance by X of 100 shares to A for $70.

For the cash settlement of a call option, the stakeholder generally recommended either (i) treating the net cash settlement as a deemed issuance of stock immediately followed by a repurchase of the same stock (resulting in no net adjustment to the stock repurchase excise tax base), or (ii) simply disregarding the cash settlement altogether for purposes of the stock repurchase excise tax. For example, assume that X issues a call option to A that entitles A to buy 100 shares of X stock for $100 ($1.00 per share) from X, and that X stock is trading at $1.30 per share on the date the option is exercised. The terms of the option require net cash settlement; thus, X pays $30 to A to settle the option.

The net cash payment in the foregoing example is the economic equivalent of (i) A paying $100 to exercise the option, (ii) X issuing 100 shares (worth $130) to A, and then (iii) X immediately redeeming those shares for $130 in cash. Thus, X

could be deemed to have issued and repurchased $130 of its shares in a transaction that fully offsets for purposes of the stock repurchase excise tax. Alternatively, X’s net cash settlement could be disregarded altogether and simply treated as the sale or exchange of an option. See section 1234(c)(2); Rev. Rul. 88-31, 1988-1 C.B. 302 (providing that the net cash settlement of a price-protection contingent value right is treated as a cash settlement of a put option subject to section 1234(c)(2)).

The Treasury Department and the IRS are of the view that, for purposes of the stock repurchase excise tax, the net cash settlement of an option should not be treated as involving a deemed issuance and repurchase of shares in the interest of simplicity and administrability. Accordingly, under the proposed regulations, the net cash settlement of an option contract would result in neither the repurchase nor the issuance of stock other than as discussed in part II.C.4 of this Explanation of Provisions. This rule would apply to the net cash settlement of an embedded option (for example, if the issuer pays the investor solely in cash on exercise of the conversion right in a convertible bond). See proposed §§58.4501-2(e)(5)(v) and 58.4501-4(f)(12).

4. Deep-in-the-Money Options

Several stakeholders recommended that options that are treated as constructively exercised at the time of their grant under Federal income tax principles (commonly referred to as “deep-in-themoney” options) should be treated similarly for purposes of the stock repurchase excise tax. For example, according to the stakeholders, if the grant of an option is treated as the issuance of the underlying stock as of the date of the grant for Federal income tax purposes, the grant of the option should be treated as an issuance of stock for purposes of the netting rule, and the cash settlement of the option should be treated as a repurchase of stock in the year of the settlement.

The stakeholders further recommended that the determination of whether an option is deep in the money should be made only at the time of grant and generally should not be revisited. Thus, if a corporation grants a call option that is exercisable or

convertible into the corporation’s stock and that is not constructively exercised at the time of grant, the stock should not be treated as issued until the option is exercised or converted into stock.

The Treasury Department and the IRS are of the view that, if a deep-in-themoney option is determined to be constructively exercised at the time of grant under Federal income tax principles, the cash settlement of such an option would be a repurchase of the underlying stock on the date of settlement under the proposed regulations. See proposed §58.4501-2(e) (5)(v). However, for a discussion of the application of the netting rule to deep-inthe-money options or other instruments not in the legal form of stock, see part XI.C.9 of this Explanation of Provisions.

5. Section 305(a) Warrants

A stakeholder recommended that, if an option to acquire a covered corporation’s stock is distributed in a distribution under section 305(a) of the Code (section 305(a) warrant), the adjustment to the stock repurchase excise tax base upon settlement of the section 305(a) warrant should be determined by reference to the strike price (and not the value of the underlying stock) because the section 305(a) distribution should be disregarded.

The Treasury Department and the IRS are of the view that the treatment of warrants distributed in a section 305 distribution should not deviate from the treatment of other types of financial instruments under the proposed regulations. The Treasury Department and the IRS view this approach as facilitating the IRS’s ability to administer and enforce the stock repurchase excise tax and enable taxpayers to apply the tax with greater certainty. Accordingly, the proposed regulations would not provide special rules for warrants distributed in a section 305 distribution. See proposed §§58.4501-2(e)(5)(v) and 58.4501-4(f) (12); see also part II.C.3 of this Explanation of Provisions (discussion of cash settlement of option contracts).

6. Integration of Qualifying Debt Instruments under §1.1275-6

A stakeholder requested clarification on how section 4501 applies to a syn

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thetic debt instrument resulting from an integrated transaction under §1.1275-6. In general, §1.1275-6 provides for the integration of a qualifying debt instrument (as defined in §1.1275-6(b)(1)) with a §1.1275-6 hedge or combination of §1.1275-6 hedges in certain circumstances. The circumstances in which §1.1275-6 may apply involve a convertible debt instrument as well as one or more options or other financial instruments involving underlying stock, provided that the combined cash flows of the financial instrument and the debt instrument permit the calculation of a yield to maturity under section 1272 of the Code or the right to the combined cash flows would qualify as a specified type of variable rate debt instrument, and other conditions are satisfied.

Under §1.1275-6(f), except as otherwise provided in published guidance, the synthetic debt instrument resulting from an integrated transaction is recognized as a single debt instrument for Federal income tax purposes for the period that the transaction qualifies as an integrated transaction and is not subject to the Federal income tax rules that would apply on a separate basis to the instruments comprising the integrated transaction if the transaction were not integrated.

Because an integrated transaction does not change the amount of stock actually repurchased or issued, the Treasury Department and the IRS are of the view that the determination of whether and when stock is repurchased or issued for purposes of the stock repurchase excise tax should be determined without regard to the integration of a qualifying debt instrument with a §1.1275-6 hedge or combination of §1.1275-6 hedges under §1.1275-6. See proposed §1.1275-6(f)(12)(iii).

D. Forfeiture or clawback of restricted stock

One stakeholder recommended that the forfeiture of restricted stock (that is, stock transferred to a service provider that is subject to a substantial risk of forfeiture at grant) that was transferred to a service provider in connection with the performance of services should not be treated as a repurchase for purposes of the stock repurchase excise tax to the extent no payment is made to the service provider

in connection with the forfeiture. Instead, the stakeholder recommended treating the stock as repurchased only to the extent of any payment received in connection with the forfeiture, with any excess of the value of the stock over the amount paid treated as a forfeiture. In other words, the stakeholder recommended using the amount paid rather than market price to compute the amount of the repurchase in this situation.

The stakeholder cited to §1.83-6(c) in support of its recommendation. Section 1.83-6(c) provides that, if (under section 83(h) of the Code and §1.83-6(a)) a deduction, an increase in basis, or a reduction of gross income was allowable to an employer in respect of a transfer of property, and if such property subsequently is forfeited, then the amount of such deduction, increase in basis, or reduction of gross income is included in the employer’s gross income for the taxable year in which the forfeiture occurs. According to the stakeholder, the fact that the employer does not recognize additional income or gain suggests that the property forfeited, to the extent it exceeds any amount paid by the employer to the forfeiting service provider, is treated as a capital contribution to the employer under section 118(a) rather than as a redemption.