The Inflation Reduction Act that passed last summer included a 1% excise tax on “repurchases” of the stock of “covered corporations” as of this year. Though it may affect few individual clients,  at least initially, it might impact investment payoffs down the road.

The IRS's interim guidance includes definitions and the circumstances under which the tax might apply and an eventual request for comments.

“Depending on their perspective, companies have responded that Treasury’s approach is both overbroad and under-inclusive,” said Jeff Tebbs, partner at Miller & Chevalier in Washington, D.C.

Another advisor said it could impact investors.

“This may directly affect our individual clients,” said Lawrence Pon, a CPA in Redwood City, Calif. “For corporations with excess cash, instead of using that money to buy back their stock, they use this money to pay more dividends to the shareholders. This could mean higher dividends for our individual clients.”

The excise tax applies to the fair market value of any stock redeemed or repurchased by the corporation during the year and may apply in two situations. The first is for stock redeemed by a covered corporation—domestic corporations traded on an established securities market—on corporate repurchases of their outstanding stock.

“This area isn’t surprising, as it’s what was expected when the new law was passed in August,” said Jim Brandenburg, a CPA and Milwaukee-based tax partner at the professional services firm Sikich. “The second situation relates to transactions that are economically similar to redemption transactions that are subject to the excise tax. This second situation was broadly written and applies in more cases than was initially thought.”

David L. Coonrod, a CPA at Coonrod Financial Group in Chatham, Ill., added that these repurchases can include not only the covered corporation, but also ‘specified affiliates,’ which are either corporations for which more than 50% of their stock is owned directly or indirectly by the covered corporation or a partnership for which 50% of the capital interests or profits interests are held by the covered corporation.

This new excise tax only applies to publicly traded corporations, Tebbs pointed out. Brandenburg added that it applies only if the fair market value of the stock subject to this tax exceeds $1 million.

“The guidance is fairly in depth, but I do think there are some areas of impact that might not be seen on the surface,” Coonrod said. “One area of note for me was preferred stock. Although not publicly traded, this class of stock could be subject to the excise tax if redeemed. Another notable impact would be distributions upon complete or partial liquidation of a covered corporation.”

Exemptions or exclusions from this excise tax include the following: the transaction is part of some reorganizations; the stock is repurchased and contributed to an employer-sponsored retirement plan, employee stock ownership plan or similar plan; or the repurchase is by a securities dealer in the ordinary course of its business, is treated as a dividend for tax purposes or is by a regulated investment company or a real estate investment trust.

Calculating this tax could get difficult, depending on the types of transactions that pertain to a corporation. “There are some fairly complicated recordkeeping requirements, especially if a company has stock redemptions, issuances or employee stock issuances, such as an employee stock ownership plan or nonqualified stock options program,” Coonrod said. “It can be a burden, especially on some of the smaller covered corporations that might not have the highest level of tax and legal counsel in-house.”

The excise tax is paid by the company, so investors generally will not have compliance obligations and will only be impacted indirectly from a financial perspective. “The excise tax may dampen share repurchases relative to other methods of returning capital to investors,” Tebbs said. “The guidance may affect how M&A transactions are structured, particularly debt-financed transactions.”

“A future Congress may be tempted to turn the dial on the tax to a higher rate, he added.

“It seems like a fairly nominal thing when you’re talking about a 1% tax, but when you start looking at the volume of dollars involved it becomes more material,” Coonrod said.