Notice 2023-2 does not expressly

address the interaction of §1.301-1(j) and the dividend exception. However, the presumption that a repurchase by a covered corporation constitutes a sale or exchange applies only to a repurchase to which section 302 or 356(a) applies. See section 3.07(6)(b)(i) of Notice 2023-2.

The Treasury Department and the IRS are of the view that no special rules are needed in response to the stakeholders’ query. In other words, because a distribution of non-qualifying property that is treated as a section 301 distribution pursuant to §1.301-1(j) is not subject to section 302 or 356(a), the Treasury Department and the IRS are of the view that such a distribution should qualify for the dividend exception (if the covered corporation has sufficient E&P) without the need for the covered corporation to rebut the presumption that the repurchase is a sale or exchange. The proposed regulations

would reflect this position. See proposed §58.4501-3(g)(2).

3. Dividend Exception and Partial Liquidation Look-Through Rule

A stakeholder requested that the proposed regulations provide the manner in which covered corporations should apply the look-through rule of section 302(e)(5) in determining the extent to which redemptions in partial liquidation are made to corporate shareholders (and, therefore, are potentially eligible for the dividend exception). Under section 302(b) (4), a redemption in partial liquidation to noncorporate shareholders is treated as a sale or exchange rather than as a section 301 distribution. However, section 302(b) (4) does not apply to shareholders that are not corporations. As a result, such shareholders potentially are eligible for exclusion under the dividend exception.

Section 302(e)(5) provides that, for purposes of determining under section 302(b)(4) whether any stock is held by a shareholder that is not a corporation, any stock held by a partnership, estate, or trust is treated as if it were held proportionately by its partners or beneficiaries. For purposes of applying this rule, the stakeholder recommended that the proposed regulations permit covered corporations to rely on SEC filings and similar filings. For support, the stakeholder contended that covered corporations generally cannot ascertain the identity of their shareholders unless the shareholders are required to disclose their ownership under applicable securities law.

For the reasons previously discussed in part X.F.1 of this Explanation of Provisions, the Treasury Department and the IRS are of the view that corporations should not be permitted to rely solely on SEC filings or similar filings for purposes of determining whether the dividend exception in section 4501(e)(6) applies. Accordingly, the proposed regulations would not adopt this recommendation. Instead, the proposed regulations would provide that covered corporations must obtain certifications from their shareholders, which must take section 302(e)(5) into account for purposes of making the certification. See proposed §58.4501-3(g) (2)(ii).

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XI. Netting Rule

A. Overview

Section 4501(c)(3) allows an adjustment for stock issued by a covered corporation, including stock issued or provided to employees of a covered corporation or its specified affiliate. Section 3.08 of Notice 2023-2 describes rules regarding the adjustment under section 4501(c)(3) (that is, the netting rule).

In general, under section 3.08(1) of Notice 2023-2, the stock repurchase excise tax base with regard to a taxable year of a covered corporation is reduced by the aggregate fair market value of stock of the covered corporation (i) issued or provided to employees of the covered corporation or employees of a specified affiliate during the covered corporation’s taxable year, and (ii) issued by the covered corporation to other persons during the covered corporation’s taxable year. For these purposes, stock is treated as issued or provided by a covered corporation at the time at which, for Federal income tax purposes, ownership of the stock transfers to the recipient. See section 3.08(2) of Notice 2023-2.

Section 3.08(3) of Notice 2023-2 describes additional rules regarding stock issued or provided to an employee of a covered corporation or specified affiliate as compensation for services performed as an employee. Such arrangements include transfers of stock in connection with the performance of services described in section 83, including pursuant to a nonqualified stock option, or pursuant to a stock option described in section 421 of the Code.

B. Treasury stock

A stakeholder requested confirmation that the transfer of treasury stock is treated as an issuance for purposes of the netting rule to the same extent as the transfer of newly issued stock. The stakeholder contended that treasury stock generally is treated in the same manner as the issuance of new stock for Federal income tax purposes, and that there is no countervailing policy reason for treating treasury stock differently than newly issued stock for purposes of the netting rule. Notice

2023‑2 does not expressly address the treatment of treasury stock because the Treasury Department and the IRS are of the view that treasury stock constitutes stock for Federal income tax purposes.

The Treasury Department and the IRS continue to be of the view that treasury stock constitutes stock for Federal income tax purposes. For the avoidance of doubt, the proposed regulations would provide explicitly that transfers of treasury stock (within the meaning of section 317(b)) are taken into account for purposes of the netting rule to the same extent as transfers of newly issued stock. See proposed §58.4501-1(b)(29).

C. Transactions not treated as issuances for purposes of the netting rule

Under section 3.08(4) of Notice 20232, the following stock is not treated as issued for purposes of the netting rule: (i) stock of a covered corporation distributed by the covered corporation to its shareholders with respect to its stock; (ii) stock issued by a covered corporation to a specified affiliate of the covered corporation; (iii) stock treated as issued by the acquiring corporation by reason of the application of section 304(a)(1) to a transaction; (iv) certain fractional shares ( see the discussion in part XIV.B of this Explanation of Provisions); (v) stock issued by a covered corporation that is a dealer in securities (to the extent the stock is issued, or otherwise is used to satisfy obligations to customers arising, in the ordinary course of the dealer’s (or an applicable acquiror’s) business of dealing in securities); and (vi) stock issued by the target corporation to the merged corporation in exchange for consideration that includes the stock of the controlling corporation in a reverse triangular merger. See sections 3.08(4)(b), (c), (e), (f), (g), and (h), respectively, of Notice 2023-2.

Additionally, under section 3.08(4)(d) of Notice 2023-2, stock issued as part of a transaction qualifying as a reorganization under section 368(a) or a distribution under section 355 is not treated as issued by the issuing corporation if (i) the stock constitutes qualifying property, (ii) the stock is used by a covered corporation to repurchase its stock in a transaction that

is a repurchase under section 3.04(4)(a)(i), (ii), (iii), or (iv) of Notice 2023-2 ( see the discussion in parts VIII.A, D, and E and IX of this Explanation of Provisions), and (iii) the repurchase is not included in the covered corporation’s stock repurchase excise tax base because that repurchase is a qualifying property repurchase (within the meaning of section 3.07(2) of Notice 2023-2). Under section 3.07(3)(e) of Notice 2023-2, stock contributions to an employer-sponsored retirement plan under the stock contribution exception are not treated as issued or provided to employees of the covered corporation or a specified affiliate under the netting rule.

1. Issuances to Specified Affiliates

Stakeholders generally recommended that issuances of stock to a specified affiliate should not be taken into account for purposes of the netting rule, for several reasons. First, respecting such issuances might lead to double counting if the stock is treated as “issued” to a specified affiliate and subsequently “provided” to that specified affiliate’s employees. See section 4501(c)(3). Second, because section 4501(c)(2) treats the acquisition of stock of a covered corporation by a specified affiliate (from a person who is not the covered corporation or a specified affiliate of such covered corporation) as a repurchase of stock of the covered corporation, allowing such a repurchase to be offset by acquisitions of the covered corporation’s stock by the specified affiliate from the covered corporation itself would be incongruous. Third, issuances of stock to a specified affiliate do not promote what the stakeholder considered to be the congressional policies underlying section 4501 (for example, promoting investment in productive capital or labor).

Under section 3.08(4)(c) of Notice 2023-2, stock issued by a covered corporation to a specified affiliate is not treated as issued. Stakeholders found this exception to the netting rule to be sensible insofar as it prevents covered corporations from eroding their stock repurchase excise tax base by creating “hook stock” (that is, issuing corporation stock held by an entity that is owned, directly or indirectly, by the issuing corporation).

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However, stakeholders also suggested that the scope of this exception is overbroad. Under a strict reading, this exception would permanently prevent the issued stock from being taken into account under the netting rule (for example, if provided to an employee of the specified affiliate), because any subsequent transfer by the specified affiliate would not technically constitute an “issuance.” Stakeholders recommended that issuances of stock by a covered corporation to its specified affiliate be disregarded only to the extent the covered corporation stock is not subsequently transferred to a party other than the covered corporation or another specified affiliate.

The Treasury Department and the IRS agree with the stakeholders. Accordingly, the proposed regulations would clarify that stock issued by a covered corporation to a specified affiliate is treated as issued for purposes of the netting rule if and when that stock is transferred by the specified affiliate during the same taxable year to a person who is not the covered corporation or a specified affiliate of that corporation, so long as (1) the covered corporation does not otherwise reduce its stock repurchase excise tax base for the issuing year with respect to the stock, and (2) the subsequent transfer by the specified affiliate is not in connection with the performance of services provided to the specified affiliate. See proposed §58.4501-4(f)(2). The first requirement is intended to ensure that the stock is not double counted if, for example, the stock is “issued” to the specified affiliate and subsequently “provided” to the specified affiliate’s employees. The second requirement is intended to ensure that stock transferred to a non-employee service provider of a specified affiliate would not qualify under this rule. See part XI.G of this Explanation of Provisions (explaining the interpretation in the proposed regulations of section 4501(c)(3)’s “issued or provided” language). Unless specifically identified, the shares of stock of the covered corporation treated as subsequently transferred by the specified affiliate are the earliest shares issued by the covered corporation to the specified affiliate. See proposed §58.4501-4(f)(2) (iii).

Under the proposed regulations, stock issued by a covered corporation in connec

tion with the performance of services for a specified affiliate would not be treated as “issued” for purposes of the netting rule. However, a transfer of stock of a covered corporation described in §1.83-6(d) by a specified affiliate to an employee (but not a non-employee service provider) of the specified affiliate would be treated as “provided” by the specified affiliate. See proposed §58.4501-4(f)(2)(iv).

Thus, under the proposed regulations, stock issued by a covered corporation to its specified affiliate (or stock that is treated as so issued under §1.83-6(d)) would be counted for purposes of the netting rule under two different provisions depending on whether the subsequent transfer by the specified affiliate is in connection with the performance of services. First, if the subsequent transfer is not in connection with the performance of services, then the stock transferred would be counted as stock “issued” by the covered corporation if and when the stock is transferred, during the same taxable year as the original issuance, to a person who is not the covered corporation or a specified affiliate of the corporation. Second, if the subsequent transfer (or deemed transfer under §1.83-6(d)) is in connection with the performance of services, then the stock transferred would be counted as stock “provided” by the specified affiliate, but only if the stock is transferred to an employee of the specified affiliate. Stock transferred to a non-employee service provider of a specified affiliate would not be counted for purposes of the netting rule. See part XI.G.2 of this Explanation of Provisions.

2. Issuances in Acquisitive Reorganizations and Split-Offs (No Double Benefit Rule)

The Treasury Department and the IRS are of the view that stock issued by the acquiring corporation to the target corporation as part of an acquisitive reorganization should not be treated as an issuance for purposes of the netting rule. See section 3.08(4)(d) of Notice 2023-2. It is the position of the Treasury Department and the IRS that allowing such an issuance to be taken into account for purposes of the netting rule would create a “double benefit” (that is, two reductions to the stock repurchase excise tax base with respect to

the same stock). In other words, (i) one reduction would be provided to the target corporation under the reorganization exception ( see section 3.07(2) of Notice 2023-2) for the use of acquiring corporation stock to repurchase target corporation stock, and (ii) a second reduction would be provided to the acquiring corporation for the issuance of that acquiring corporation stock under the netting rule. The Treasury Department and the IRS observe that the identical concern arises with regard to stock issued by Controlled to Distributing in a D reorganization occurring as part of a split-off under section 355.

One stakeholder asserted that, if the proposed regulations adopt the stakeholders’ recommendation to exclude acquisitive reorganizations from the stock repurchase excise tax, no “double benefit” would occur because the issuance of qualifying property by the acquiring corporation would not be offset against the target corporation’s stock repurchase excise tax base. However, the proposed regulations would not adopt the recommendation to exclude acquisitive reorganizations from the stock repurchase excise tax. See part VIII.A.2 of this Explanation of Provisions.

Based on the foregoing, the proposed regulations would provide that stock issued as part of a transaction qualifying as a reorganization under section 368(a) or as a distribution under section 355 is disregarded for purposes of the netting rule if (i) the stock constitutes qualifying property, (ii) the stock is used by a covered corporation to repurchase its stock in a transaction qualifying as a reorganization under section 368(a) or a split-off under section 355 (whether or not the split-off is part of a D reorganization), and (iii) that repurchase is not included in that corporation’s stock repurchase excise tax base because the repurchase is a qualifying property repurchase. See proposed §58.4501-4(f)(3).

3. Issuances in Spin-Offs and Split-Ups

A stakeholder also recommended that issuances by Controlled to Distributing in a D reorganization occurring as part of a section 355 distribution should not be treated as issuances for purposes of the netting rule if the section 355 distribution is either a split-off or a spin-off. The stake

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holder noted that, under Notice 2023-2, the no double benefit rule does not disregard the Controlled stock issued to Distributing in a D reorganization occurring as part of a spin-off because, unlike in a split-off, Distributing does not use the Controlled stock to repurchase its own stock. However, the stakeholder found no policy justification for the disparate treatment of spin-offs and split-offs that qualify under section 355 with respect to the netting rule. The stakeholder also questioned the propriety of allowing a recently distributed Controlled to begin its life as a covered corporation with a positive “reserve” of issuances equal to its net value for purposes of the netting rule.

The Treasury Department and the IRS agree with the stakeholder and are of the view that Controlled stock issued to Distributing in a section 355 transaction should be disregarded for purposes of the netting rule. Thus, the proposed regulations would provide that any stock issued by Controlled in a distribution qualifying under section 355 (or so much of section 356 as relates to section 355) is not treated as an issuance for purposes of the netting rule. See proposed §58.4501-4(f)(9).

4. Section 305 Distributions

Under section 3.08(4)(b) of Notice 2023-2, stock of a covered corporation distributed by the covered corporation to its shareholders with respect to its stock is not treated as issued for purposes of the netting rule. Several stakeholders recommended that stock issued by a covered corporation in a distribution to which section 305(a) of the Code applies (for example, a pro rata stock distribution) should not be taken into account for purposes of the netting rule. These stakeholders reasoned that, if their recommendation were not adopted, a covered corporation could avoid the stock repurchase excise tax by engaging in transactions that create share issuances for the netting rule but have no meaningful dilutive effect on the covered corporation’s equity capital. In support of this recommendation, one stakeholder analogized a section 305(a) distribution to a circular flow of cash (that is, the distribution of cash by a corporation to its shareholders, followed by the reinvestment of all the distributed cash in the corporation)

that is disregarded for Federal income tax purposes. The stakeholder contended that such a transaction should not be treated as creating a stock issuance for purposes of the netting rule.

With regard to distributions by a covered corporation that are described in section 305(b), stakeholders recommended that issuances of stock by the covered corporation should be taken into account for purposes of the netting rule if the receipt of that stock is taxable to the shareholder under section 305(b). As one example, stakeholders suggested that such distributions should be treated as share issuances for purposes of the netting rule if any distributee shareholder can elect to be paid either in stock or in property under section 305(b)(1). The stakeholders asserted that the ability of distributee shareholders to elect to receive stock or cash (or other property) in a section 305(b)(1) distribution should be viewed as economically equivalent to (i) the distribution of cash or other property to the distributee shareholders, followed by (ii) the use of that cash or other property by some distributee shareholders to purchase stock from the covered corporation.

According to the stakeholders, the use of cash or other property by some distributee shareholders to purchase stock from the covered corporation in a section 305(b)(1) distribution presumably would be treated as an issuance for purposes of the netting rule. Therefore, the stakeholders concluded that stock issued in a section 305(b)(1) distribution should not be disregarded solely because the covered corporation does not receive money or services in exchange for that stock.

As reflected in section 3.08(4)(b) of Notice 2023-2, the Treasury Department and the IRS are of the view that distributions by a covered corporation of its own stock should not be taken into account for purposes of the netting rule, regardless of whether the distributions are taxable to the covered corporation’s shareholders under section 305(b). Although the recipients of stock distributions under section 305(a) and (b) are subject to different Federal income tax consequences, the Treasury Department and the IRS are of the view that this distinction should not affect the application of the stock repurchase excise tax because the statutory language of sec

tion 4501(c)(3) does not focus on treatment of shareholders. Therefore, the Treasury Department and IRS are of the view that disparate treatment should not be provided under the netting rule for different types of section 305 distributions.

For the foregoing reasons, and to facilitate the ability for the IRS to administer and enforce the stock repurchase excise tax, the proposed regulations would not accept the stakeholders’ recommendation. Instead, distributions by a covered corporation of its own stock would not be taken into account for purposes of the netting rule. See proposed §58.4501-4(f)(1).

5. Stock-for-Stock Exchanges

A stakeholder recommended that stock issued in an E reorganization should not be treated as an issuance for purposes of the netting rule. For support, the stakeholder contended that the proposed regulations should preclude covered corporations from avoiding the stock repurchase excise tax by engaging in transactions with no meaningful dilutive effect on the corporation’s equity capital. In other words, the stakeholder presented the same rationale as the stakeholder’s rationale for recommending that stock issued in a distribution to which section 305(a) applies should not be treated as an issuance for purposes of the netting rule. For similar reasons, the stakeholder also recommended that stock issued in an exchange under section 1036 of the Code should not be treated as an issuance for purposes of the netting rule.

The Treasury Department and the IRS continue to be of the view that stock issued in an E reorganization should not be treated as an issuance for purposes of the netting rule because such stock already is taken into account under the reorganization exception. Under that exception ( see section 3.07(2) of Notice 2023-2 and the discussion in part X.A of this Explanation of Provisions), the fair market value of stock repurchased by the covered corporation in an E reorganization using qualifying property is a reduction for purposes of computing the covered corporation’s stock repurchase excise tax base. Therefore, if the issuance of such qualifying property were treated as an issuance for purposes of the netting rule, the covered corporation’s stock repurchase excise tax

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base would be reduced twice as a result of a single stock issuance. The proposed regulations reflect this view. See proposed §58.4501-4(f)(3); see also part XI.C.2 of this Explanation of Provisions (discussion of no double benefit rule).

Similarly, the Treasury Department and the IRS agree with the stakeholder that stock issued in a section 1036 exchange should not be treated as an issuance for purposes of the netting rule. Accordingly, the proposed regulations would provide that stock issued in a section 1036 exchange is not treated as an issuance for purposes of the netting rule. See proposed §58.4501-4(f)(8).

6. Issuances in F Reorganizations

A stakeholder recommended that stock issued in an F reorganization should not be treated as an issuance for purposes of the netting rule. The Treasury Department and the IRS continue to be of the view that stock issued in an F reorganization should not be treated as an issuance for purposes of the netting rule because that stock already is taken into account to reduce the covered corporation’s stock repurchase excise tax base under the reorganization exception. Therefore, if the issuance of such qualifying property were treated as an issuance for purposes of the netting rule, the covered corporation’s stock repurchase excise tax base would be reduced twice as a result of a single stock issuance. The proposed regulations reflect this view. See proposed §58.4501-4(f)(3); see also part XI.C.2 of this Explanation of Provisions (discussion of no double benefit rule).

In addition, the proposed regulations would articulate explicitly the view of the Treasury Department and the IRS that F reorganizations should be treated for stock repurchase excise tax purposes in the same manner in which they are treated under the Code and Treasury regulations. In particular, the proposed regulations would reflect the view of the Treasury Department and the IRS that, for purposes of the netting rule, the transferor corporation and the resulting corporation in an F reorganization should be treated as the same corporation. See §1.381(b)-1(a)(2) (providing that, in the case of a transaction qualifying as an F reorganization, the

acquiring corporation is treated just as the transferor corporation would have been treated had there been no reorganization). As a result, the transferor corporation’s issuances in the portion of the taxable year preceding an F reorganization may offset the resulting corporation’s repurchases in the portion of the taxable year following the F reorganization. Likewise, the resulting corporation’s issuances in the portion of the taxable year following an F reorganization may offset the transferor corporation’s repurchases in the portion of the taxable year preceding the F reorganization. See proposed §58.4501-4(b)(4).

7. Issuances by a Dealer in Securities

Under section 3.08(4)(g) of Notice 2023-2, any stock issued by a covered corporation that is a dealer in securities is not treated as issued to the extent the stock is issued, or otherwise is used to satisfy obligations to customers arising, in the ordinary course of the dealer’s business of dealing in securities. No feedback was received on the treatment described in Notice 2023-2 of issuances by a dealer in securities, and the proposed regulations would retain the approach described in Notice 2023-2. See proposed §58.45014(f)(6).

8. Amounts Excluded Under the Stock Contribution Exception

Covered corporation stock contributed to or purchased by an employer-sponsored retirement plan is not treated as issued or provided for purposes of the netting rule. See part XI.G.3 of this Explanation of Provisions for further discussion.

9. Instruments Not in the Legal Form of Stock

Because taxpayers generally can choose the form of the instruments that they issue, the Treasury Department and the IRS are concerned that allowing taxpayers to immediately offset their current repurchases by issuing instruments not in the legal form of stock that are treated as stock for Federal income tax purposes at issuance (non-stock instruments) may create the potential for abuse. For example, a taxpayer seeking to avoid the application

of the stock repurchase excise tax might issue deep-in-the-money call options, which the taxpayer takes the position are treated as stock for Federal income tax purposes, to accommodation parties with the mutual understanding that such options would never be exercised. While a taxpayer could in principle similarly issue stock to an accommodation party in order to reduce its stock repurchase excise tax base, the issuance of stock by a publicly traded corporation is subject to legal, regulatory, and practical restrictions that do not or may not apply to an instrument that is not in the legal form of stock. In such a case, respecting the issuance of the option as an issuance of stock at the time of issuance for purposes of the netting rule could allow taxpayers to unduly reduce their stock repurchase excise tax liability.

Accordingly, pursuant to section 4501(f), the proposed regulations provide an anti-avoidance rule to address this concern. Under proposed §58.4501-4(f)(13), the issuance of a non-stock instrument, including certain deep-in-the money options, would not be treated as an issuance of stock for purposes of the netting rule until the instrument is repurchased, and that the amount of the issuance under the netting rule would be limited to the lesser of the fair market value of the nonstock instrument at the time of its issuance or repurchase. The taxpayer would be entitled to regard the issuance for purposes of the netting rule for the repurchased nonstock instrument only if it timely reports the repurchase as a repurchase of a nonstock instrument. In order to prevent taxpayers from taking inconsistent positions with respect to comparable non-stock instruments, a taxpayer that fails to timely report a repurchase of a non-stock instrument as such will not be entitled to regard any issuances for purposes of the netting rule for comparable non-stock instruments repurchased within the five taxable years ending on the last day of the repurchase year, unless the failure to timely report the earlier repurchase was due to reasonable cause. See proposed §58.4501-4(f)(13) (ii)(D). Under the proposed regulations, a comparable non-stock instrument is a non-stock instrument that has substantially similar economic terms as the repurchased non-stock instrument, regardless of whether the comparable non-stock

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instrument and the repurchased non-stock instrument have the same legal form. See id .

Notwithstanding the rules described above for issuances, the Treasury Department and IRS are of the view that the repurchase of an instrument that meets the definition of stock at issuance should be treated as a repurchase, regardless of the legal form of such instrument. Given the potential for abuses of the netting rule involving non-stock instruments, the Treasury Department and the IRS are of the view that the different treatment for nonstock instruments under the netting rule as compared to the rule for repurchases is justified because a taxpayer generally can control whether to issue a particular instrument in the form of stock.

D. Carryovers and carrybacks of issuances of preferred stock

Several stakeholders raised concerns regarding regulated financial institutions that issue additional tier 1 preferred stock to comply with regulatory requirements. In particular, stakeholders noted that, although regulated financial institutions often must replace redeemed additional tier 1 preferred stock with new additional tier 1 preferred stock, timing considerations and the regulatory approval process often prevents such issuances from occurring during the same taxable year as the repurchases. As a result, regulated financial institutions may not be able to match their redemptions of additional tier 1 preferred stock with their issuances of replacement additional tier 1 preferred stock under the netting rule.

The stakeholders recommended that the proposed regulations permit covered corporations to carry forward or carry back for one taxable year the aggregate amount of issuances by the covered corporation of additional tier 1 preferred stock that exceed the aggregate amount of repurchases of additional tier 1 preferred stock by that covered corporation for a taxable year. One stakeholder suggested that the proposed regulations incorporate such a carryforward and carryback rule for all types of preferred stock.

The Treasury Department and the IRS are of the view that the stakeholder’s recommended carryforward and carryback

provision is inconsistent with the plain language of the statute. Section 4501 provides clearly that the stock repurchase excise tax must be determined for a covered corporation on a taxable-year-by-taxable-year basis, and the amount of repurchases for a taxable year may be adjusted solely to take into account issuances by the covered corporation during that same taxable year. See section 4501(a) (imposing the stock repurchase excise tax on “stock of the corporation which is repurchased by such corporation during the taxable year”); section 4501(c)(3) (reducing the amount of repurchases for a taxable year “by the fair market value of any stock issued by the covered corporation during the taxable year”). In this regard, under section 3.03(3)(c) of Notice 2023-2, any reductions in the stock repurchase excise tax base under the statutory exceptions or the netting rule in excess of the aggregate fair market value of all repurchases during the taxable year are not carried forward or backward to preceding or succeeding taxable years of the covered corporation. Accordingly, the proposed regulations would not adopt this recommendation.

E. Fair market value of shares issued pursuant to the conversion of a convertible debt instrument

A stakeholder recommended that, for purposes of the netting rule, the fair market value of shares issued pursuant to the conversion of a convertible debt instrument should be the market price of the shares on the date of issuance, rather than the consideration actually paid by the holder to acquire the instrument. The stakeholder recommended this approach based in part on the plain language of section 4501(c)(3), which refers to “the fair market value of any stock issued by the covered corporation during the taxable year” ( emphasis added ).

The Treasury Department and the IRS agree with the stakeholder. Consistent with section 3.08(5) of Notice 2023-2, the Treasury Department and the IRS are of the view that, for purposes of the netting rule, the fair market value of stock issued generally should be the market price of the stock on the date the stock is issued. See proposed §58.4501-4(e)(1). Although the proposed regulations do not expressly

address stock issued upon the conversion of a convertible debt instrument, such stock would fall within the scope of this general rule. 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.

F. Net share settlement

A stakeholder noted that, if stock is transferred in connection with the performance of services, an employer may withhold some of the stock to cover the exercise price, tax withholding obligations, or other withholding obligations. The stakeholder noted that the stock withheld could be viewed either as transferred to the service provider and then repurchased by the covered corporation, or as never having been issued.

Under section 3.08(3)(a)(ii) of Notice 2023-2, stock withheld by a covered corporation or a specified affiliate to satisfy an employer’s income tax withholding obligation described in section 3402 of the Code, or an employer’s employment tax withholding obligation described in section 3102 of the Code, is not treated as stock issued or provided to an employee by the covered corporation or specified affiliate. Under section 3.08(3)(a)(iii) of Notice 2023-2, stock withheld by a covered corporation or a specified affiliate to satisfy the exercise price of a stock option also is not treated as stock issued or provided by the covered corporation or specified affiliate to an employee.

As reflected in section 3.08(3)(a)(ii) and (iii) of Notice 2023‑2, the Treasury Department and IRS are of the view that stock withheld to satisfy an employer’s withholding obligation under section 3102 or 3402, or to satisfy the exercise price of a stock option, is not issued or provided by the covered corporation or a specified affiliate. This position is consistent with the section 83 rules.

Stakeholders noted that stock is withheld in other situations (such as State or foreign tax withholding) and requested clarification on whether those situations also would not result in the issuance or provision of stock. To provide greater clarity regarding the treatment of net share

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settlements, these proposed regulations would expand Notice 2023-2 to cover all situations involving net share settlements. Accordingly, the proposed regulations would provide that stock withheld by the covered corporation or specified affiliate to satisfy the exercise price of a stock option or to cover any withholding obligation is not treated as issued or provided under the netting rule. See proposed §58.4501-4(f)(11).

A similar result would apply to the delivery of stock under an option not issued in connection with the performance of services, including pursuant to an option embedded in a convertible bond. See part XIV.B of this Explanation of Provisions (discussion of the treatment of cash paid in lieu of a fractional share).

G. Special rules for stock issued or provided to service providers

1. Issuances to Service Providers Other than Employees

Stakeholders requested clarification that the netting rule applies to a covered corporation’s issuances of its stock to service providers other than employees. The Treasury Department and the IRS agree that the same rules for determining whether covered corporation stock is issued, the amount of stock issued, and the timing of an issuance should apply to both employee and non-employee service providers of a covered corporation for purposes of the netting rule. The Treasury Department and the IRS are of the view that applying the same rules to all compensatory stock transfers by a covered corporation would improve administrability of the stock repurchase excise tax because the timing and value of stock issued or provided in connection with the performance of services is determined under section 83 for both employee and non-employee service providers.

Accordingly, these proposed regulations would clarify that the netting rule applies to issuances by a covered corporation to both employee and non-employee service providers of the covered corporation. See proposed §58.4501-4(b)(1)(i). However, as discussed in part XI.G.2 of this Explanation of Provisions, covered

corporation stock provided by a specified affiliate in connection with the performance of services by a non-employee of the specified affiliate would not qualify for the netting rule.

2. Meaning of Stock “Issued or Provided” in Section 4501(c)(3)

A stakeholder noted that section 4501 neither defines the term “provided” nor explains the distinction between the terms “issued” and “provided” in section 4501(c)(3). The stakeholder suggested that one way the distinction between these terms could be explained is by construing stock “issued” to mean a transfer of newly issued stock, and stock “provided” to mean a transfer of treasury shares. However, the stakeholder recommended against this interpretation because there is no policy reason for treating newly issued shares and treasury shares differently. As discussed in part XI.B of this Explanation of Provisions, the Treasury Department and IRS are of the view that newly issued shares and treasury shares should be treated the same way for purposes of the netting rule. See proposed §58.45011(b)(29). Instead, the stakeholder recommended that stock “issued” should be interpreted to mean covered corporation stock issued directly by the covered corporation to its employees or other service providers. In contrast, stock “provided” should be interpreted to mean covered corporation stock transferred by a specified affiliate (which cannot issue covered corporation stock) to its employees.

The Treasury Department and IRS agree with the foregoing interpretation. A specified affiliate may provide stock in the covered corporation, rather than the specified affiliate’s own stock, as compensation for services provided by the specified affiliate’s employees. Thus, this interpretation would not interfere with existing stock-based compensation arrangements. Moreover, because section 4501(c)(3) applies to transfers by a specified affiliate to its employees, stock provided by the specified affiliate in connection with the performance of services by its employees (but not by its non-employee service providers) would qualify for the netting rule under these proposed regulations.

Under §1.83-6(d), if a covered corporation transfers its stock in connection with the performance of services for a specified affiliate, then (i) the covered corporation is treated as having contributed the stock to the capital of the specified affiliate, and (ii) the specified affiliate is treated as immediately transferring the covered corporation stock to the service provider. Thus, under the proposed regulations, if the transfer is to an employee of the specified affiliate in connection with the performance of services for the specified affiliate, the specified affiliate would be treated as transferring the stock to an employee in connection with the performance of services for the specified affiliate and the transfer would be regarded for purposes of the netting rule. See proposed §58.4501-4(f)(2)(iv).

3. Amounts Excluded Under the Stock Contribution Exception

A stakeholder noted that section 4501 does not explicitly preclude a covered corporation from reducing the amount of its stock repurchase excise tax under the netting rule using repurchased stock that was excluded from the stock repurchase excise tax under the statutory exception for contributions to employer-sponsored retirement plans. See section 4501(e) (2) and the discussion in part X.B of this Explanation of Provisions. The stakeholder requested clarification that stock that is excluded from the stock repurchase excise tax under the stock contribution exception may not then be used to reduce the stock repurchase excise tax base under the netting rule.

The Treasury Department and the IRS agree that permitting an offset against the stock repurchase excise tax base under both the stock contribution exception and the netting rule would be inconsistent with the statute. Further, stock contributed to or purchased by an employer-sponsored retirement plan is issued or provided to the plan, not a service provider. Thus, consistent with section 3.07(3)(e) of Notice 2023-2, these proposed regulations would provide that stock contributed to or purchased by an employer-sponsored retirement plan does not reduce the stock repurchase excise tax base under the netting rule. See proposed §58.4501-4(f)(10).

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4. Net Share Settlement of Options Issued in Connection with the Performance of Services

A stakeholder requested guidance explaining how to determine the amount of the offset under the netting rule for options settled in stock. The stakeholder recommended that, if an option is “in the money” (that is, if the exercise price is less than the fair market value of the stock on the date of exercise), then the stock repurchase excise tax base should be reduced by the full fair market value of the stock, and not merely the exercise price.

The Treasury Department and the IRS agree with the stakeholder. The Treasury Department and the IRS are of the view that, for purposes of the stock repurchase excise tax, the net share settlement of options issued in connection with the performance of services should be treated in the same manner as the settlement of other options issued in connection with the performance of services. See proposed §58.4501-4(e)(5) and (f)(11).

5. “Sell to Cover” Arrangements

A stakeholder described a “sell to cover” arrangement for stock-based compensation as a transaction in which a third party (usually a broker) facilitates the issuance of stock-based compensation by providing amounts necessary to cover a withholding obligation (for example, to cover Federal income taxes that must be withheld on the transferred shares). The stakeholder suggested that this transaction should be treated as an issuance or provision of stock for purposes of the netting rule.

The Treasury Department and the IRS agree with the stakeholder. In these arrangements, stock is issued or provided to the service provider, or to a third party on behalf of the service provider, and then immediately sold to cover a withholding obligation, and the fair market value of the amounts necessary to cover the withholding obligation is included in the service provider’s gross income under section 83. Therefore, as reflected in section 3.08(3) (a)(iv) of Notice 2023-2, these proposed regulations would provide that stock transferred in these arrangements is treated as issued or provided for purposes of the netting rule. See proposed §58.4501-4(c)(2).

6. Time when Stock is Considered Issued or Provided to an Employee or Other Service Provider

a. In general

Consistent with section 3.08(3)(b)(i) of Notice 2023-2, these proposed regulations would provide that stock is treated as issued or provided to an employee or other service provider when beneficial ownership transfers for tax purposes. See proposed §58.4501-4(d)(2). Beneficial ownership ordinarily transfers when the service recipient initiates the transfer or when the stock is vested. However, if the service provider makes a valid election under section 83(b), beneficial ownership transfers on the date the property was transferred. See section 83. Stock transferred to a grantor trust (for example, a Rabbi trust) is not treated as issued or provided until beneficial ownership transfers to the service provider for tax purposes.

b. Restricted stock

Several stakeholders requested clarification as to when restricted stock is treated as issued for purposes of the netting rule. The stakeholders recommended treating restricted stock as issued when the stock is treated as beneficially owned under the section 83 rules. Thus, such stock would be treated as issued only if and when the shares become substantially vested, unless the recipient makes a section 83(b) election with respect to the shares.

The Treasury Department and the IRS agree that restricted stock should be treated as issued for purposes of the netting rule when the service provider recipient of the stock is treated as the beneficial owner for Federal income tax purposes under the section 83 rules. Under section 3.08(3)(b)(i) of Notice 2023-2, stock is issued or provided by a covered corporation or a specified affiliate to an employee as of the date the employee is treated as the beneficial owner of the stock for Federal income tax purposes, and that an employee generally is treated as the beneficial owner of the stock when the stock is transferred by the covered corporation (or the specified affiliate) to the employee and the stock is substantially vested within the meaning of §1.83‑1(b). Thus, stock trans

ferred pursuant to a vested stock award or restricted stock unit is issued or provided when the covered corporation or specified affiliate initiates payment of the stock. See section 3.08(3)(b)(i) of Notice 2023-2.

Stock that is not substantially vested within the meaning of §1.83‑3(b) generally is not issued or provided to the employee until the employee vests in the stock, unless the employee makes a valid election under section 83(b), in which case the stock is treated as issued or provided to the employee as of the transfer date. See sections 3.08(3)(b)(i) and (iii) of Notice 2023-2. Stock transferred to an employee pursuant to an option described in §1.83-7 or section 421 or a stock appreciation right is issued or provided to the employee as of the date the employee exercises the option or stock appreciation right. See section 3.08(3)(b)(ii) of Notice 2023-2. Consistent with section 3.08(3)(b)(i) of Notice 2023-2, the proposed regulations would provide that stock that is not substantially vested within the meaning of §1.83-3(b) generally is not treated as issued or provided to the employee until the stock vests. See proposed §58.45014(d)(2)(i). However, if the employee makes a valid election under section 83(b), the stock would be treated as issued or provided to the employee as of the transfer date. See proposed §58.4501-4(d) (2)(iii).

Alternatively, one stakeholder recommended treating restricted stock as issued at the time the award is granted (that is, when the stock is treated as outstanding for securities law purposes). However, the Treasury Department and the IRS are of the view that applying the section 83 rules to determine when restricted stock is treated as issued is appropriate, and that applying the section 83 rules consistently would decrease the compliance burden on taxpayers and the administrative burdens on the IRS. Accordingly, the proposed regulations would not adopt this alternative recommendation.

7. Valuing Stock Issued or Provided to an Employee or Other Service Provider

A stakeholder requested guidance on how to determine the fair market value of stock issued or provided to an employee for purposes of the netting rule. The stake

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holder recommended using the market price on the date of the issuance or provision, with specific rules to determine fair market value for certain kinds of stock.

The Treasury Department and IRS generally agree with the stakeholder. Consistent with section 3.08(3)(c) of Notice 2023-2, these proposed regulations would cross-reference the section 83 rules to determine the fair market value of stock issued or provided to an employee or other service provider under the netting rule. See proposed §58.4501-4(e)(5). Under the section 83 rules, the fair market value of the stock is determined as of the date that beneficial ownership transfers to the service provider.

The Treasury Department and the IRS are of the view that applying the section 83 valuation rules should reduce the compliance burden on taxpayers and the administrative burden on the IRS, as taxpayers also apply the section 83 rules for other tax purposes. Under the proposed regulations, the section 83 valuation rules also would apply if the covered corporation or specified affiliate issues or provides stock pursuant to the service provider exercising an option (including an option described in section 421) or making a valid section 83(b) election on restricted stock. See proposed §58.4501-4(e)(5).

A stakeholder also requested clarification on valuing stock that is not included in United States income, such as stock issued to a non-resident employee who provides services outside the United States. The proposed regulations would provide that, under the netting rule, the fair market value of stock is determined under the section 83 rules, regardless of whether the income inclusion is governed by section 83. Thus, for example, the fair market value of stock issued pursuant to a stock option described in section 421 and stock issued to a non-resident alien for services performed outside the United States is determined using the section 83 rules. See proposed §58.4501-4(e)(5).

XII. Mergers and Acquisitions with Post- Closing Price Adjustments

A. Overview

A stakeholder provided recommendations regarding post-closing price

adjustments in M&A transactions. This stakeholder explained that adjustments may include additional payments to the target corporation’s shareholders based on achievement by the target corporation’s business of certain milestones or fluctuations in value of the acquiring corporation’s stock (earnout), or the forfeiture of consideration by the target corporation’s shareholders to compensate the acquiring corporation for breaches of representations and warranties or for other indemnification obligations (indemnification payment).

This stakeholder also noted that consideration provided at closing in a tax-free reorganization may include shares that are issued as part of an earnout (earnout shares) or that are subject to forfeiture to satisfy indemnification obligations. Alternatively, the acquiring corporation may have a right to repurchase certain shares for a price that is below the stock’s fair market value (below-market repurchase). Despite being subject to forfeiture or a below-market repurchase, the stakeholder explained that such shares potentially could be treated as owned by the former target corporation shareholders for Federal income tax purposes at the time of issuance.

B. When shares issued as part of an earnout or potentially subject to an indemnification payment are treated as issued

The stakeholder recommended that shares issued by an acquiring corporation should be treated as issued for purposes of the netting rule regardless of whether those shares are subject to forfeiture or a below-market repurchase. Essentially, the stakeholder recommended that the proposed regulations should permit an acquiring corporation to offset the fair market value of that corporation’s repurchases during the taxable year by the fair market value of all shares issued by that corporation in an M&A transaction during that taxable year if those shares are treated as issued for Federal income tax purposes.

The Treasury Department continue to be of the view that stock should be treated as issued when ownership of the stock transfers to the recipient for Federal income tax purposes. See section

3.08(2) of Notice 2023-2. This treatment is consistent with the stakeholder’s recommendation, and therefore the Treasury Department and the IRS have provided no special rule in the proposed regulations. See proposed §58.4501-4(d)(1); see also part III.B.1 of this Explanation of Provisions (discussion of timing of issuances and repurchases).

C. Fair market value of shares issued as part of an earnout or potentially subject to an indemnification payment

A stakeholder recommended that, for purposes of the netting rule, the fair market value of shares that potentially are subject to forfeiture or a below-market repurchase should be the trading price of such shares on the date of issuance (rather than on the date of forfeiture or repurchase). For support, the stakeholder contended that (i) the parties generally do not expect the acquiring corporation to make significant claims for indemnification payments, and (ii) discounting the fair market value to reflect the likelihood of forfeiture or a below-market repurchase would be administratively cumbersome for the IRS and taxpayers.

Although Notice 2023-2 does not expressly address this issue, it does reflect the stakeholder’s recommendation. Under Notice 2023-2, if the shares were not disregarded under the no double benefit rule, the fair market value of the shares would be determined using their market price on the date of issuance, consistent with the stakeholder’s recommendation regarding the treatment of shares potentially subject to an indemnification payment. The proposed regulations would maintain this treatment and would not include special rules to determine the fair market value of such shares.

In contrast, the stakeholder also recommended that the fair market value of earnout shares should be discounted to reflect the present value and likelihood of payment. The Treasury Department and the IRS are of the view that incorporation of the stakeholder’s recommendation into the proposed regulations would introduce uncertainty and complexity into stock valuation for purposes of the netting rule. Furthermore, the stakeholder’s recommendation would be inconsistent with the

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statutory language of section 4501(c)(3), which simply references the “fair market value” of stock issued or provided. As a result, the proposed regulations would not include special rules to determine the fair market value of earnout shares.

D. Forfeiture of shares received as part of an earnout or potentially subject to an indemnification payment

One stakeholder generally recommended that the forfeiture of earnout shares should not be treated as a repurchase. The stakeholder asserted that such a forfeiture would not constitute a section 317(b) redemption because the corporation would have exchanged no property for the earnout shares. Similarly, the stakeholder also contended that the forfeiture should not be treated as an economically similar transaction because no capital would have left the corporation.

In contrast, the stakeholder recommended that the forfeiture of earnout shares as part of an indemnification payment should be treated as a repurchase of those shares, because the target corporation’s former shareholders would have economically benefited from the forfeiture by not needing to use cash or other property to make the indemnification payment. Therefore, in the stakeholder’s view, the acquiring corporation should be treated as repurchasing the shares in an amount equal to the value of the indemnification claim, as determined based on the documents governing the transaction.

Under Notice 2023-2, a forfeiture of shares would not be treated as a repurchase, because the forfeiture is neither a section 317(b) redemption nor treated as an economically similar transaction. However, there would be an issuance for purposes of the netting rule when ownership of those shares transfers to the recipient for Federal income tax purposes, even though those shares potentially are still subject to forfeiture.

For the same reasons discussed in part II.D of this Explanation of Provisions, the Treasury Department and the IRS are of the view that a forfeiture of shares should count as a repurchase if an issuance of such shares would be counted under the netting rule (in other words, those shares should be treated consistently for pur

poses of repurchases and issuances). Consequently, because the issuance of earnout shares or shares subject to an indemnification payment would be taken into account for purposes of the netting rule when those shares transfer to the recipient for Federal income tax purposes, the proposed regulations would treat the forfeiture of those shares as a repurchase at the time of forfeiture. See proposed §58.4501-2(e) (4)(vi). To facilitate the ability for the IRS to administer and enforce the stock repurchase excise tax, the amount of the repurchase would equal the market price of the forfeited stock on the date of forfeiture under the general rule in proposed §58.4501-2(h)(1) and would not be determined by the underlying transaction documents.

E. Below-market repurchase of shares received as part of an earnout or potentially subject to an indemnification payment

A stakeholder recommended that, if the acquiring corporation repurchases earnout shares in a below-market repurchase, only the amount paid should be reflected in the acquiring corporation’s stock repurchase excise tax base. According to the stakeholder, proposed regulations adopting that approach would be appropriate because the negotiated price of the earnout shares would reflect the restrictions applicable to those shares and the circumstances in which that stock is repurchased. In contrast, the market price of those earnout shares would reflect an inaccurate price

• that is, the market price would fail to reflect the same restrictions to which the earnout shares would be subject.

The Treasury Department and the IRS continue to be of the view that the fair market value of stock issued by a covered corporation should be the market price on the date of issuance. See section 3.08(5) of Notice 2023-2. The Treasury Department and the IRS incorporated this position in Notice 2023-2 to reduce unnecessary complexity for taxpayers and facilitate the ability for the IRS to administer and enforce the stock repurchase excise tax. In addition, the Treasury Department and the IRS observe that the approach described in Notice 2023-2 ensures that repurchases and issuances would be valued based on

identical methodologies, thereby ensuring symmetrical treatment. Accordingly, the proposed regulations would adopt the approach described in Notice 2023-2, including with regard to stock that is subject to a below-market repurchase.

XIII. Troubled Companies

In section 6.02(3) of Notice 20232, the Treasury Department and the IRS requested comments on whether special rules should be provided for bankrupt or troubled companies. For example, the Treasury Department and the IRS asked whether a section 317(b) redemption occurring as part of a restructuring of a bankrupt or troubled company should be excluded from the definition of “repurchase.”

One stakeholder recommended that troubled companies generally should not be subject to the stock repurchase excise tax. According to the stakeholder, application of the stock repurchase excise tax would further burden troubled companies and would provide troubled companies with an incremental incentive to reject otherwise equitable restructuring plans to the extent those plans would implicate the stock repurchase excise tax. The stakeholder recommended that an exemption apply to exchanges of equity for other property by a corporation that either is in a title 11 case or is insolvent (within the meaning of section 108(d)(3) of the Code) immediately prior to the exchange. The stakeholder further recommended that the proposed regulations confirm that the stock repurchase excise tax does not apply to acquisitive reorganizations under section 368(a)(1)(G) (acquisitive G reorganizations) and exchanges of distressed debt.

In contrast, another stakeholder recommended that no special rules be provided for troubled companies, other than a modification of the valuation rule for repurchases occurring as part of a restructuring. The stakeholder also recommended that the definition of “acquisitive reorganization” include acquisitive G reorganizations. According to the stakeholder, if a troubled company distributes value to existing shareholders, there is no reason to exempt such a distribution from the stock repurchase excise tax if the distribution otherwise is a repurchase within

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the scope of the stock repurchase excise tax. The stakeholder also stated that, in most situations, the value of stock issued to creditors in exchange for their claims will significantly exceed the value of any recovery received by existing shareholders, such that the netting rule would prevent any stock repurchase excise tax from being owed.

With respect to the valuation rule for repurchases, the stakeholder stated that the general rule for valuing repurchased stock (by reference to the “market price” of repurchased stock) could lead to inappropriate outcomes for troubled companies undergoing a restructuring. According to the stakeholder, the recovery amount received by a shareholder in exchange for its stock may be significantly less than the market price of the stock determined immediately after such repurchase. For support, the stakeholder asserted that the recovery amount will be determined when the stock is worth very little, but the market price (if determined immediately after the restructuring) may be much higher.

The Treasury Department and the IRS are of the view that special rules for troubled companies are neither necessary nor appropriate to carry out the purposes of the stock repurchase excise tax. In reaching this view, the Treasury Department and the IRS observe that a troubled company generally would not be treated as repurchasing its stock in either a title 11 restructuring or an out-of-court debt restructuring. In each type of transaction, it is the understanding of the Treasury Department and the IRS that the troubled company’s stock typically would be cancelled solely as a result of the title 11 restructuring or the out-ofcourt debt restructuring, rather than as any redemption or repurchase. Accordingly, such cancellation would not constitute a redemption within the meaning of section 317(b). See section 317(b) (defining a redemption as a corporation’s acquisition of its stock from a shareholder in exchange for “property” (within the meaning of section 317(a))). For the same reason, the Treasury Department and the IRS are of the view that such a transaction should not constitute an economically similar transaction under the proposed regulations. See proposed §58.4501-2(e)(4).

The Treasury Department and the IRS agree that the definition of an “acquisitive

reorganization” should include acquisitive G reorganizations. See part VIII.A of this Explanation of Provisions (discussion of acquisitive reorganizations). The Treasury Department and the IRS are of the view that an exchange between a target corporation and its shareholders pursuant to an acquisitive G reorganization should be subject to the stock repurchase excise tax to the same extent as in other acquisitive reorganizations. That is, a stock repurchase excise tax liability should arise from an exchange in an acquisitive G reorganization to the extent the target corporation shareholders exchange their target corporation stock for non-qualifying property. Accordingly, the proposed regulations would include acquisitive G reorganizations in the definition of “acquisitive reorganization.” See proposed §58.4501-1(b)(1).

XIV. Additional Miscellaneous Issues

A. Ordering rule for statutory exceptions and netting rule

1. Overview

Stakeholders requested a rule to clarify the order in which taxpayers should apply the de minimis exception, the other statutory exceptions, the netting rule, and any other exceptions set forth in regulations. Under Notice 2023-2, a covered corporation computes its stock repurchase excise tax base for a taxable year by (i) determining the aggregate fair market value of all repurchases, (ii) reducing that amount to the extent any statutory exceptions apply, and then (iii) reducing that amount under the netting rule. The determination whether the de minimis exception applies is made before applying any statutory exceptions or adjustments under the netting rule (that is, after step (i)).

One stakeholder recommended an approach involving the following steps. First, a taxpayer should compute its gross repurchases for the taxable year, taking into account any exclusions from the definitions of “stock” and “repurchase.” Second, the taxpayer should determine whether the de minimis exception applies. (If so, no further computations would be necessary.) Third, the taxpayer should apply the other statutory exceptions to reduce the amount computed in the first

step. Finally, the taxpayer should apply the netting rule to the amount computed in the third step, thereby arriving at the net repurchase amount subject to the stock repurchase excise tax.

The stakeholder’s recommendation generally is consistent with section 3.03(3) (a) of Notice 2023-2. The proposed regulations would maintain the ordering rules described in Notice 2023-2. See proposed §58.4501‑2(c)(1).

2. Section 4501(e)

One stakeholder contended that the plain meaning of the lead-in language in section 4501(e)—which states that “Subsection (a) shall not apply” in the situations described in section 4501(e)(1) through (6)—is that an amount excluded under one of these statutory exceptions should not first be treated as part of a share repurchase. In other words, the stakeholder interpreted that lead-in language to provide that taxpayers should not be required to include all repurchases in the stock repurchase excise tax base and then reduce the amount of that base by the amount of those repurchases that qualify for a statutory exception.

The Treasury Department and the IRS are of the view that the lead-in language in section 4501(e) does not affect the definition of “repurchase” under section 4501(c) (in other words, that lead-in language applies solely to section 4501(a)). The lead-in language in section 4501(e) states that section 4501(a), which imposes a one percent excise tax on repurchases, does not apply in certain specified situations. The lead-in language in section 4501(e) does not state that those specified situations are not “repurchases” within the meaning of section 4501(c). Indeed, each of the statutory exceptions in section 4501(e) expressly involves a repurchase. See, for example, section 4501(e)(1) (“to the extent that the repurchase is part of a reorganization…”) and (6) (“to the extent that the repurchase is treated as a dividend…”) ( emphasis added ). Therefore, the Treasury Department and the IRS are of the view that Notice 2023-2 properly implements the lead-in language in section 4501(e), and the proposed regulations would not incorporate the stakeholder’s recommendation.

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3. De Minimis Rule

Several stakeholders objected to the approach described in Notice 2023-2 that the determination of whether the de minimis exception applies be made before the application of any other statutory exceptions or adjustments under the netting rule. One stakeholder contended that this approach imposes a compliance burden by requiring taxpayers to consider the application of the stock repurchase excise tax whenever taxpayers engage in a transaction that may involve a deemed exchange of stock. Stakeholders also contended that this approach would have the effect of eliminating the de minimis exception or rendering its application arbitrary in certain circumstances.

For example, one stakeholder noted that, if a covered corporation repurchases $2 million of its stock and contributes $1.5 million of that stock to an ESOP, the incidence of the stock repurchase excise tax would depend on the order in which the statutory exceptions are applied. If the de minimis exception were to be applied before the stock contribution exception, the stock repurchase excise tax would be imposed on $0.5 million. Conversely, if the de minimis exception were to be applied after the stock contribution exception, then the stock repurchase excise tax would not apply at all because the corporation’s $0.5 million of repurchases would not exceed the $1 million de minimis threshold.

As another example, the stakeholder assumed that a covered corporation changes the par value of its stock with a fair market value of $1 billion. For Federal income tax purposes, the change in par value would be treated as an E reorganization in which the corporation’s shareholders are deemed to exchange their old stock for newly issued stock. The stakeholder noted that, under the approach described in Notice 2023-2, (i) this exchange would be included in the stock repurchase excise tax base computation as a $1 billion repurchase, and (ii) although this amount wholly would be offset under the reorganization exception, the inclusion of the transaction in the stock repurchase excise tax base would completely exhaust the allowance under the de minimis exception.

The Treasury Department and the IRS are of the view that applying the de minimis exception before the other statutory exceptions is consistent with the statutory language and structure of section 4501. By its terms, the de minimis exception applies “in any case in which the total value of the stock repurchased during the taxable year does not exceed $1,000,000…” ( emphasis added ). The determination of whether a transaction is a repurchase under section 4501(c) is independent of the statutory exceptions in section 4501(e). Therefore, the Treasury Department and the IRS are of the view that the de minimis exception should be measured against a covered corporation’s gross repurchases (that is, a covered corporation’s repurchases before reduction under another statutory exception or the netting rule).

The proposed regulations would provide that a covered corporation would compute its stock repurchase excise tax base for a taxable year by (i) determining the aggregate fair market value of all repurchases, (ii) reducing that amount to the extent any statutory exceptions apply, and then (iii) reducing that amount under the netting rule. See proposed §58.45012(c)(1). The determination of whether the de minimis exception applies would be made before applying any other statutory exceptions or adjustments under the netting rule (that is, after step (i)). See proposed §58.4501-2(b)(2).

4. Reporting Requirements

The Treasury Department and the IRS also are of the view that any covered corporation that makes a repurchase must comply with the applicable reporting requirements for the stock repurchase excise tax, even if all the covered corporation’s repurchases are eligible for a statutory exception or are offset by issuances. See proposed §58.6011-1 as proposed elsewhere in this issue of the Federal Register ; see also part XVII of this Explanation of Provisions.

B. Fractional shares

If cash is paid to shareholders in lieu of fractional shares in connection with a reorganization under section 368(a), the payment of cash could be treated as an issuance of stock immediately followed

by an offsetting repurchase of a fractional share. See, for example, Rev. Rul. 66-35, 1966-2 C.B. 116 (applying this “deemed issuance and repurchase” treatment to cash paid in lieu of a fractional share to conclude that the receipt of such cash does not violate the “solely for voting stock” requirement of section 368(a)(1)(B) and (C)); Rev. Rul. 69-34, 1969-1 C.B. 105 (applying such treatment to cash paid in lieu of a fractional share in an E reorganization); Rev. Rul. 74‑46, 1974-1 C.B. 85 (same, for an F reorganization).

Under section 3.04(3)(b) of Notice 2023-2, a payment by a covered corporation of cash in lieu of a fractional share is not a repurchase if (i) the payment is carried out as part of a transaction that qualifies as a reorganization under section 368(a) or as a distribution to which section 355 applies, or pursuant to the settlement of an option or similar financial instrument (for example, a convertible debt instrument or convertible preferred share), (ii) the cash is not separately bargained-for consideration, (iii) the payment is carried out solely for administrative convenience, and (iv) the amount of cash paid to the shareholder in lieu of a fractional share does not exceed the value of one full share of the stock of the covered corporation.

Several stakeholders recommended that the stock repurchase excise tax should not apply to any such payments, so long as the cash paid represents solely a mechanical rounding-off of fractional shares that otherwise would be issued and is not separately bargained-for consideration.

The Treasury Department and the IRS continue to be of the view that the deemed issuance and repurchase of fractional shares pursuant to a section 368(a) reorganization, section 355 distribution, or settlement of an option or similar financial instrument should be disregarded for purposes of section 4501, so long as the general criteria described in Notice 2023-2 are satisfied. Accordingly, the proposed regulations would retain this rule with the clarification that the value of one share of stock is determined on a class-by-class basis. See proposed §58.4501-2(e)(3)(ii).

C. Cash paid to dissenting shareholders

If a target corporation shareholder exercises dissenters’ rights with respect

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to a reorganization, the shareholder’s shares typically are cancelled as a matter of corporate law. Upon the ultimate resolution of the shareholder’s claim, those shares typically are deemed to have been acquired for cash in connection with the reorganization.

The Federal income tax treatment of payments to dissenting shareholders generally depends upon the source of the cash. If the cash is sourced from the target corporation, the acquisition generally is treated as occurring as part of a redemption separate from the reorganization. See, for example, Rev. Rul. 68-285 (holding that the acquisition of target corporation stock for acquiring corporation voting stock is a B reorganization notwithstanding the creation of an escrow account to pay dissenting shareholders for their stock). In contrast, if the cash is sourced from the acquiring corporation, the acquisition of the dissenting shareholders’ stock may be treated as acquired by the acquiring corporation in connection with the reorganization. See, for example, Rev. Rul. 73-102, 1973-1 C.B. 186 (holding that the “solely for voting stock” requirement of section 368(a)(1)(C) is satisfied even though the acquiring corporation makes cash payments to dissenting shareholders for their target corporation stock).

A stakeholder recommended that cash paid to dissenting shareholders should not be treated as a repurchase, regardless of the source of the cash, and regardless of whether the dissenting shareholders’ rights are exercised in the context of a taxable or tax-free transaction. According to the stakeholder, a shareholder’s decision to exercise dissenters’ rights is outside the control of the target corporation, which has no influence over how much cash ultimately may be paid to dissenters.