IRS Issues Final Regulations on Stock Buyback Tax

Summary

On November 21, 2025, the IRS and the Department of the Treasury issued final regulations (the “Final Regulations”) on the application of Section 4501 of the Internal Revenue Code, which imposes a 1% excise tax on certain repurchases of corporate stock (the “Buyback Tax”).[1] The Final Regulations depart notably from the Proposed Regulations issued on April 9, 2024, which significantly narrow the circumstances in which the Buyback Tax applies. Among other changes, the Final Regulations:

• Eliminate the “funding rule” that would have expanded the Buyback Tax to repurchases of stock of non-U.S. corporations treated as “funded” by a U.S. affiliate.
• Significantly narrow the application of the Buyback Tax to M&A transactions, including by excluding most LBO/take-private transactions (regardless of the source of consideration) and acquisitive reorganizations (even those with taxable “boot”) from the scope of the Buyback Tax.
• Exclude “plain vanilla” preferred stock from the scope of the Buyback Tax, while generally maintaining the applicability of the Buyback Tax to other preferred stock – subject to transition relief for mandatory redeemable stock issued prior to the effectiveness of the Buyback Tax.

Background

On August 16, 2022, President Biden signed the Inflation Reduction Act into law, which included the imposition of the Buyback Tax on certain repurchases of corporate stock after December 31, 2022. The Buyback Tax generally applies to U.S. corporations whose stock is traded on an established securities market (such a corporation, a “Covered Corporation”).[2] Under the statute, the Buyback Tax is equal to 1% of the fair market value of “repurchases” with respect to stock of the Covered Corporation, generally comprising redemptions by the Covered Corporation and transactions that Treasury determines to be “economically similar” to redemptions,[3] subject to certain statutory exceptions. The statute also provides that the amount of redemptions subject to the Buyback Tax in a taxable year is reduced by the fair market value of stock issuances made within the same year by the Covered Corporation (the “Netting Rule”).[4] The statute included regulatory powers to carry out the purposes of the Section, including addressing special classes of stock and preferred stock and to “prevent the avoidance of” the purposes of the Buyback Tax statute.[5]

On December 27, 2022, the IRS and the Department of the Treasury issued Notice 2023-2 (the “Notice”) providing initial guidance on the Buyback Tax with respect to, among other things, redemptions of preferred stock, redemptions in complete liquidation, tax-free reorganizations, repurchases of foreign corporate stock, and leveraged buyouts (see prior memo). On April 9, 2024, the IRS and the Department of the Treasury issued two Notices of Proposed Rulemaking (the “Proposed Regulations”), which expanded on and clarified the guidance in the Notice (see prior memo). This alert focuses on the major changes made by the Final Regulations compared to the Proposed Regulations.

Discussion

A. Foreign-Parented Groups – Elimination of Funding Rule

For foreign corporations traded on an established securities market (a “Foreign Covered Corporation”), the Buyback Tax statute is generally limited to purchases of the stock of a Foreign Covered Corporation that are made by a 50%-owned U.S. affiliate.[6] The Notice would have dramatically increased the scope of the Buyback Tax to repurchases by Foreign Covered Corporations or their 50%-owned foreign affiliates of the stock of the Foreign Covered Corporation by providing that such repurchases “funded” by a 50%-owned U.S. affiliated would be subject to the Buyback Tax if a “principal purpose” of the funding was to avoid the Buyback Tax.[7] Further, such a purpose would have been deemed to exist “per se” if the acquisition occurred within two years of a funding by any means (other than a distribution) from a U.S. affiliate (the “Funding Rule”).[8] The Funding Rule as provided in the Notice was criticized as being overly broad in comparison to the targeted language in the statute which applied the Buyback Tax to foreign corporations in very specific and rare circumstances, whereas the Funding Rule as crafted in the Notice would have applied the scope of the Buyback Tax to repurchases by foreign corporations otherwise outside the statute merely as a result of ordinary course cash management transactions involving a U.S. affiliate.

The Proposed Regulations significantly narrowed the Funding Rule, including by eliminating the “per se” rule. However, the Proposed Regulations retained certain aspects of the Funding Rule, including the “principal purpose” test.[9] While the Funding Rule as revised by the Proposed Regulations provided a measure of relief from a taxpayer perspective the automatic sweep of the “per se” rule, it continued to be criticized as subjecting foreign corporations to the Buyback Tax beyond the intent of the statute. In particular, the Proposed Regulations made clear that a principal purpose to fund a repurchase was sufficient to be considered a principal purpose to avoid the Buyback Tax.[10] In other words, even if a repurchase would have been carried out in exactly the same manner as if the Buyback Tax had not been enacted, and even if the foreign-parented group never considered the Buyback Tax in structuring the funding and repurchase transactions, funding by a U.S. affiliate could nevertheless be treated as having an avoidance purpose that triggers the Buyback Tax. Since cash is fungible, foreign-parented groups faced significant uncertainty as to what extent a repurchase by a foreign parent would be treated as “funded” when that same foreign parent also received cash directly or indirectly from a U.S. affiliate, adding significant complexity to their cash management activities.

In light of these concerns, the Final Regulations eliminate the Funding Rule entirely.[11]

B. M&A Transactions

The Buyback Tax generally applies to “repurchases,” which include both redemptions of Covered Corporation stock for cash or other property and any “economically similar” transactions.[12] Under the Notice and Proposed Regulations, certain M&A transactions were classified as “economically similar” transactions that could be treated as repurchases triggering the Buyback Tax.[13] Notably, those rules treated taxable and tax-free transactions very differently – and even treated economically equivalent tax-free transactions very differently depending on which tax-free structure was employed.[14]

The preamble to the Final Regulations notes in several places that Treasury has determined that Congress did not intend to reach transactions that fundamentally restructure ownership or control.[15] Accordingly, the Final Regulations significantly narrow the application of the Buyback Tax to M&A transactions in several respects.

1. LBOs and Take-Private Transactions

Under the Proposed Regulations, leveraged buyouts (“LBOs”) and other taxable acquisitions of the stock of a target corporation in a “take private” transaction were generally treated as repurchases for purposes of the Buyback Tax to the extent treated as funded by the target corporation.[16] This approach created diverging treatment between transactions where debt was borrowed at an acquiring-entity or “bidco” level versus “debt push-down” transactions.

Under the Final Regulations, purchases executed as part of a transaction in which the otherwise Covered Corporation ceases to be publicly traded are excluded from the definition of a repurchase.[17]

2. Acquisitive Reorganizations

Under the Proposed Regulations, exchanges of shares by shareholders of a Covered Corporation in tax-free acquisitive reorganizations were generally treated as subject to the Buyback Tax to the extent such shareholders received taxable “boot” in the exchange.[18]

The Final Regulations exclude acquisitive reorganizations from the scope of the Buyback Tax, even to the extent of taxable “boot.”[19] The Final Regulations also remove the rule that would have prevented acquiror stock issued as part of the reorganization from being taken into account by the acquiror as issued for Netting Rule purposes.[20]

3. Spin-Offs & Split-Offs

Under the Proposed Regulations, tax-free spin-offs in which a Covered Corporation (“Parent”) distributes stock of a controlled corporation (“Spinco”) to its shareholders were treated as transactions which are not economically similar to redemptions and therefore not subject to the Buyback Tax except to the extent of taxable “boot” in exchange for Parent stock in connection with the spin-off.[21] The Final Regulations generally retain this treatment, but also clarify that stock issued in connection with the spin-off is disregarded for purposes of the Netting Rule.[22]

In contrast, split-offs in which Parent exchanges Spinco stock for Parent stock were treated as under the Proposed Regulations as economically similar to redemptions.[23] However, the exchange of Parent for Spinco stock is exempted – effectively limiting the application of the Buyback Tax to taxable “boot” for split-offs as well, but making the issuance of Spinco stock in the split-off ineligible for the Netting Rule. The Final Regulations generally retain this treatment.[24]

4. Recapitalizations

The Final Regulations apply to recapitalizations treated as “E” reorganizations in a generally similar manner to the Proposed Regulations, with certain clarifications. Under the Final Regulations, the Buyback Tax applies to a recapitalization only if there is an exchange of stock for non-stock consideration.[25] Debt-for-debt recapitalizations are confirmed as beyond the scope of the Buyback Tax.[26] The Final Regulations also clarify that, to the extent stock exchanged in a recapitalization is attributable to dividend arrearages, the fair market value attributable to dividends in arrears is exempt from the Buyback Tax.[27]

5. Liquidations

Under the Proposed Regulations, liquidations generally were not treated as subject to the Buyback Tax if treated as entirely taxable or as entirely tax-free.[28] However, in certain situations where a Covered Corporation is 80-percent owned by a corporate parent and also by one or more minority stockholders, a liquidation could be treated as tax-free with respect to the controlling parent but taxable with respect to the minority stockholders.[29] Under the Proposed Regulations, the taxable portion of such a partially taxable liquidation would be treated as an “economically similar” transaction subject to the Buyback Tax.[30]

The Final Regulations eliminate this inconsistency by excluding all liquidations from the scope of the Buyback Tax.[31]

C. Capital Markets

1. Preferred Stock

Commentators have repeatedly requested Treasury narrow the scope of “stock” of a Covered Corporation subject to the Buyback Tax to address “special classes of stock and preferred stock.”[32] Some have recommended that special treatment be considered for, among other things, “plain vanilla” preferred with debt-like features or mandatory redemptions of preferred stock that commentators have argued are not akin to a “buyback.” Some commenters suggested excluding redemption of preferred stock entirely.

The Notice generally took a broad view of “stock” to include any instrument issued by a corporation that is treated as stock for U.S. federal income tax purposes at the time of issuance, regardless of whether that stock is traded on an established securities market.[33] The Proposed Regulations generally followed this approach, with a limited exception for “additional tier 1 preferred stock” qualifying as additional tier 1 capital for regulatory purposes.[34]

Citing Congressional intent, the Final Regulations decline to adopt a blanket exemption for preferred stock, and generally continue to treat preferred stock of a Covered Corporation as stock potentially subject to the Buyback Tax.[35] However, the Final Regulations do meaningfully expand the exceptions for preferred stock:

• Preferred stock qualifying as “plain vanilla” under Section 1504(a) of the Code is excluded from the definition of “stock.”[36] Accordingly, repurchases of such stock are not subject to the Buyback Tax, but issuances of such stock are also disregarded for purposes of the Netting Rule.
• Limited transition relief is provided exempting redemptions of preferred stock issued prior to enactment of the Buyback Tax and subject to mandatory redemption (or a unilateral holder put) from the time of issuance until the time of redemption.[37]
• The additional tier 1 preferred stock exemption is expanded to cover certain Farm Credit System entities and saving and loan holding companies with significant insurance operations. However, Treasury declined to extend the exemption to foreign-parented banks in light of the elimination of the Funding Rule.[38]

2. Non-RIC ‘40 Act Funds

Under the Proposed Regulations, repurchases by a RIC or REIT were generally exempted from the Buyback Tax.[39] The preamble notes that ‘40 Act funds that fail to qualify as RICs (e.g., due to investments in publicly traded partnerships exceeding certain limits) despite having an organizational structure, operations, securities laws and accounting standards that are generally similar to funds taxed as RICs – including that they are generally required to redeem shares at the demand of a shareholder.[40] Accordingly, the Final Regulations extend the RIC/REIT exemption to open-end funds and interval funds registered under the ‘40 Act but not qualifying as RICs for tax purposes.[41]

D. Other Changes

The Final Regulations contain numerous other changes from the Proposed Regulations, including:

• Elimination of the “constructive specified-affiliate acquisition rule” treating certain indirect acquisitions of Covered Corporation stock as repurchases.[42]
• Simplified standards for demonstrating that an otherwise taxable repurchase is taxed as a dividend and thus not subject to the Buyback Tax.[43]
• Adoption of rules treating instruments not in the form of stock as non-stock for Netting Rule purposes in certain “potentially abusive” transactions.[44]
• Aligning the rules for issuances of stock to service providers of an affiliate as between employees and non-employee service providers.[45]

E. Effective Dates

The Final Regulations are generally effective for repurchases of Covered Corporation stock occurring after December 31, 2022 and issuances and provisions of stock of a Covered Corporation occurring during taxable years ending after December 31, 2022.[46]

Certain specified rules under the Final Regulations only apply to repurchases, issuances or provisions of stock of a Covered Corporation occurring after April 12, 2024.[47] Even in such cases, however, a taxpayer may apply the Final Regulations under the general post-2022 effective date rule as long as the taxpayer does so consistently.[48]

The Final Regulations contain procedures for refunds in the case of a taxpayer that previously applied the Notice and Proposed Regulations.[49]