Recent Tax Developments and Guidance

This alert provides a summary of recent tax developments arising from the various guidance provided by the Internal Revenue Service (the “IRS”) and the US Department of the Treasury (“Treasury”) at the end of 2022. This includes additional guidance on the new taxes imposed by the Inflation Reduction Act of 2022 (the “IRA”), including the Corporate Stock Buyback Excise Tax and the Corporate Alternative Minimum Tax. This alert also discusses the delay in modified information reporting requirements for third party settlement organizations and cryptocurrency brokers, as well as certain automatic changes from the Tax Cuts and Jobs Act of 2017 (the “TCJA”).

Corporate Stock Buyback Excise Tax

On December 27, 2022, the IRS and Treasury issued Notice 2023-02 (the “Excise Tax Notice”) to provide taxpayers with interim guidance regarding the application of Section 4501 of the Internal Revenue Code (the “Code”). The IRA added Section 4501 to the Code, as discussed in a previous alert. Code Section 4501 imposes an excise tax on domestic corporations whose stock is traded on an established securities market (“Covered Corporations”) equal to 1% of the fair market value of certain repurchases of stock by a Covered Corporation beginning January 1, 2023 (the “Excise Tax”). The Treasury is yet to issue proposed regulations under Code Section 4501. The rules set forth in the Excise Tax Notice may be relied upon until such regulations are issued. What follows is a summary of some key provisions of the Excise Tax Notice.

Scope of the Excise Tax:

• The Excise Tax Notice confirms that the Excise Tax applies to a Code Section 317(b) redemption (i.e., a corporation’s acquisition of its stock from a shareholder in exchange for property), excluding certain redemptions discussed below, as well as any “economically similar transaction.” The Excise Tax Notice sets forth the following exclusive list of “economically similar transactions,” which notably include common reorganizations under Code Section 368 and certain distributions under Code Section 355:
  • acquisitive reorganizations (i.e., Code Section 368(a)(1)(A) reorganizations (including by reason of Code Section 368(a)(2)(D) or Code Section 368(a)(2)(E)), Code Section 368(a)(1)(C) reorganizations and acquisitive Code Section 368(a)(1)(D) reorganizations) where the target corporation is a Covered Corporation and the target corporation shareholders exchange their target corporation stock as part of the acquisitive reorganization,
  • Code Section 368(a)(1)(E) reorganizations (i.e., recapitalizations),
  • Code Section 368(a)(1)(F) reorganizations (i.e., a mere change in identity, form or place of organization of one corporation),
  • split-offs where certain shareholders exchange stock of the distributing corporation (which is a Covered Corporation) for stock of the controlled corporation, and
  • complete liquidations to which both Code Sections 331 and 332 apply (in such transactions, the Code Section 331 components will be treated as a “repurchase” while the Code Section 332 components will not).

However, the application of the Excise Tax to reorganizations under Code Section 368 and split-offs under Code Section 355 is limited by the “qualifying property” exception discussed in the “Qualifying Property Exception” section below.

• In addition to the exclusive list of “economically similar transactions,” the Excise Tax Notice also provides a nonexclusive list of transactions that will not be treated as economically similar to a Code Section 317(b) redemption:
  • complete liquidations to which either Code Section 331 or Code Section 332 solely apply, and
  • divisive transactions under Code Section 355 other than split-offs (i.e., spin-offs where the distributing corporation distributes stock of the controlled corporation to the distributing corporation’s existing shareholders and such stock is not in exchange for stock of the existing shareholders).
• The Excise Tax Notice also provides that two types of redemptions under Code Section 317(b) will not be treated as a “redemption” for purposes of the Excise Tax:
  • deemed redemptions pursuant to Code Section 304(a)(1), and
  • payments of cash in lieu of fractional shares carried out solely for non-tax reasons in connection with (i) a Code Section 368(a) reorganization, (ii) a Code Section 355 distribution (i.e., split-offs or spin-offs) or (iii) the settlement of an option or similar financial instrument.
• In addition to the Covered Corporation’s repurchase of its own stock, the Excise Tax will also be imposed on the Covered Corporation if its “specified affiliate” acquires stock of the Covered Corporation from an unrelated party. “Specified affiliate” means, with regard to any Covered Corporation, (i) any corporation more than 50 percent of the stock of which is owned (by vote or by value), directly or indirectly, by the Covered Corporation, and (ii) any partnership more than 50 percent of the capital interests or profits interests of which is held, directly or indirectly, by the Covered Corporation.

Qualifying Property Exception:

• While the Excise Tax applies to many common types of tax-deferred transactions, the Excise Tax Notice provides that the Excise Tax will not apply to the extent of “qualifying property” received by shareholders. “Qualifying property” is property received by a shareholder in a redemption or “economically similar transaction” that does not give rise to gain or loss to the shareholder under Code Section 354 or Code Section 355. Accordingly, the “qualifying property” exception generally limits the effect of the Excise Tax in the realm of “economically similar transactions” (such as an acquisitive reorganization, Code Section 368(a)(1)(E) reorganizations, Code Section 368(a)(1)(F) reorganizations and split-offs) such that the Excise Tax only applies to the extent of “boot” (i.e., cash, other property and non-qualified preferred stock) received by shareholders in such transactions.

Redemption of Nontraded Stock:

• After Section 4501 entered the Code, there was some uncertainty as to the whether a redemption of nontraded preferred stock (or other nontraded stock) by a Covered Corporation would be subject to the Excise Tax. The Excise Tax Notice contains an example confirming that a redemption of any stock of a Covered Corporation will be subject to the Excise Tax. Under this example, a Covered Corporation redeemed preferred stock that was not traded on an established securities market. While the stock actually redeemed was not traded on an established market, the redemption was nevertheless subject to the Excise Tax under this example.

Target Funded Acquisition:

• To the extent consideration given in exchange for stock of a Covered Corporation in a buyout transaction is funded by the Covered Corporation and not by the acquirer of the Covered Corporation, the portion of the consideration funded by the Covered Corporation will be subject to the Excise Tax.
• The Excise Tax Notice provides two examples of such buyout transactions. In the first example, the Covered Corporation funds $60x of the $100x to be received by its shareholders upon the sale of 100% of the shareholder’s Covered Corporation stock to an acquirer. In the second example, a transitory subsidiary of an acquirer borrows $60x and funds $60x of the $100x to be paid to the Covered Corporation shareholders. The Covered Corporation then merges with the transitory subsidiary of the acquirer, survives the merger and assumes the loan. Finally, the Covered Corporation shareholders receive $100x in exchange for 100% of their stock in the Covered Corporation. In both examples the Covered Corporation is treated as redeeming stock equal to $60x which is subject to the Excise Tax.

Exception for Dealers in Securities:

• The Excise Tax Notice describes rules clarifying the exception for repurchase by a dealer in securities in the ordinary course of business. Under those rules, a redemption by a dealer in securities will not be treated as a redemption only if the dealer (i) accounts for the stock as securities held primarily for sale to customers in the ordinary course, (ii) disposes of the stock within a timeframe consistent with the holding of stock for sale to customers in the ordinary course and (iii) does not sell or otherwise transfer the stock to a Covered Corporation other than a sale that otherwise satisfies the foregoing requirements.

Excise Tax Reporting:

• The Excise Tax Notice states that the Excise Tax must be reported on Form 720, Quarterly Federal Excise Tax Return. Treasury noted that it expects that forthcoming proposed regulations will provide that the Excise Tax will be reported once per taxable year in the first full quarter after the close of a Covered Corporation’s taxable year.

Corporate Alternative Minimum Tax

On December 27, 2022, the IRS and Treasury issued Notice 2023-07 (the “CAMT Notice”) to provide guidance on the application of corporate alternative minimum tax (the “CAMT”) established in the IRA. The CAMT is a 15% corporate alternative minimum tax imposed on the adjusted financial statement income (“AFSI”) of any “applicable corporation.” AFSI is the net income or loss set forth on the corporation’s applicable financial statement for the year, subject to certain adjustments. Under the IRA, an “applicable corporation” is a corporation with average annual AFSI exceeding $1 billion (the “$1 Billion Threshold Test”) for a three-taxable-year period ending after December 31, 2021.

Simplified Method:

• The CAMT Notice notably creates a “simplified method” to provide a safe harbor calculation for determining whether a corporation is an “applicable corporation” for the first taxable year beginning after December 31, 2022. Under the simplified method, a corporation will use its income or loss reflected on its applicable financial statement to calculate AFSI, without incorporating most of the adjustments permitted under the $1 Billion Threshold Test. The corporation will then apply a $500 million threshold test:
  • If the corporation’s AFSI does not exceed an average of $500 million over a three-year rolling period, then it will not be subject to the CAMT.
  • If the corporation’s AFSI exceeds an average of $500 million over a three-year rolling period, then the corporation will instead rely on the $1 Billion Threshold Test to determine its “applicable corporation” status.

Additional Guidance:

• The CAMT Notice also provides limited guidance for six other key areas:
  • AFSI calculation for covered nonrecognition transactions—for purposes of calculating AFSI, any financial accounting gain or loss resulting from a covered nonrecognition transaction (i.e., a transaction that qualifies for nonrecognition treatment for US federal income tax purposes and does not result in any amount of gain or loss for US federal income tax purposes with respect to the corporation or partnership, as applicable) is not taken into account,
  • AFSI treatment for covered transactions,
  • CAMT issues with depreciation adjustments related to Code Section 168 property,
  • AFSI and cancellation of indebtedness and bankruptcy,
  • the relationship between certain partnerships and applicable corporation status, and
  • the treatment of certain tax credits and the proceeds from certain tax credits under the CAMT.

The IRS and Treasury intend on issuing additional interim guidance and proposed regulations on the CAMT. Until these are provided, the IRS and Treasury recommend relying on the interim guidance in the CAMT Notice. The IRS and Treasury also request comments from practitioners on specific issues related to the CAMT Notice.  

Delay for the Lowered Form 1099-K De Minimis Reporting Threshold for TPSOs

On December 23, 2022, the IRS and Treasury issued Notice 2023-10 to provide guidance on certain information reporting changes under the American Rescue Plan Act of 2021 (the “ARP”). The ARP lowered the Form 1099-K de minimis reporting threshold for third-party settlement organizations (“TPSOs”), like PayPal and Venmo. The lower threshold requires a TPSO to file a Form 1099-K for any payee with over $600 in aggregate transactions for the calendar year. Under the prior threshold, a TPSO was only required to file a Form 1099-K, Payment Card and Third Party Network Transactions, for payees with (i) over $20,000 in aggregate transactions and (ii) over 200 transactions for the calendar year.

The lower threshold was initially effective for calendar years beginning after December 31, 2021, under the ARP. Pursuant to Notice 2023-10, the IRS will treat the 2022 calendar year as a transition period for the lower threshold. A TPSO is required to file a Form 1099-K with respect to any payee that exceeds the lower threshold for calendar years beginning after December 31, 2022. TPSOs should follow the prior threshold for the 2022 calendar year.

Delay for Cryptocurrency Form 1099 Information Reporting Requirements

On December 23, 2022, the IRS and Treasury issued Announcement 2023-02 to provide guidance on certain information reporting changes under the Infrastructure Investment and Jobs Act of 2021 (the “Infrastructure Act”). The Infrastructure Act modified existing information reporting requirements for brokers to account for their cryptocurrency customers. Pursuant to the Infrastructure Act’s changes, brokers would have to prepare and file Form 1099s for cryptocurrency customers.

Delayed Infrastructure Act Reporting Requirements:

• The Infrastructure Act changes were initially effective for (i) cryptocurrencies acquired after December 31, 2022, and (ii) cryptocurrency returns and statements required to be filed and furnished after December 31, 2023. However, Announcement 2023-02 indicated that the IRS and Treasury will not require brokers to follow the Infrastructure Act changes until final regulations are issued regarding the modified cryptocurrency information reporting requirements.
• Until final regulations are issued, brokers should instead follow existing information reporting requirements for cryptocurrency customers. The IRS and Treasury reiterated that taxpayers must still report income received from cryptocurrency transactions and answer the cryptocurrency question on Form 1040, US Individual Income Tax Return and Form 1040-SR, US Tax Return for Seniors.

Material Changes to Certain TCJA Provisions Continue to Roll Into the Code

The Tax Cuts and Jobs Act of 2017 (the “TCJA”) contained a number of taxpayer favorable provisions that have recently expired or are set to expire in the near term.

• Applicable as of the beginning of 2022, EBIT (rather than EBITDA) is used for purposes of calculating the limit on interest deductions imposed by the TCJA’s version of Code Section 163(j). Under Code Section 163(j), interest deductibility is limited to 30% of adjusted taxable income. As a result of the change, adjusted income is now determined based on a lower EBIT amount instead of the more beneficial EBITDA amount, which was available for the initial four years following the implementation of the TCJA. Notably, certain businesses are exempted from the change to EBIT.
• Also beginning in 2022, research and experiment (“R&E”) expenses are now capitalized and amortized over five or fifteen years, rather than being immediately deducted as had been the historical treatment. Despite optimism that immediate deductibility would be restored, no action has been taken.
• The start of the ratcheting down of “bonus depreciation” is effective beginning in 2023. Since the implementation of the TCJA through 2022, full expensing of certain acquired business assets had been available to businesses to offset income. This “bonus depreciation” now begins to sunset with 80% depreciation allowed in 2023, 60% in 2024, 40% in 2025, 20% in 2026 and then a return to the pre-TCJA depreciation thereafter.
• Looking to the not-so-distant future, a number of other provisions of the TCJA are set to become less favorable for non-corporate taxpayers. The end of 2025 will see important provisions expire. These looming expirations involve key personal tax rules, such as reverting to the law as it existed before 2018 with higher tax brackets, a lower standard deduction and the former, more broadly applicable, alternative minimum tax, as well as returning to more onerous estate tax rules. The child tax credit will also return to its less beneficial pre-TCJA version. However, some of the effects of these changes will be offset by the return of certain favorable provisions such as the ability to fully take into account state and local taxes and the ability to make use of certain miscellaneous itemized deductions.
• Importantly for the business community, beginning in 2026, three of the TCJA’s new cross-border regimes (GILTI, BEAT and FDII) will have their provisions adjusted to potentially increase a taxpayer’s tax bill. Additionally, the Code Section 199A deduction benefitting owners of sole proprietorships, partnerships and S corporations operating a qualified trade or business, is set to expire as of the beginning of 2026.