There Is No Evidence That The 1% Stock-Buyback Tax Has Slowed Repurchases, But A Proposed 4% Tax Might.

Executives say that a bill that raises the share-buyback tax may result in more dividends rather than stock repurchases.

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The corporate world has mostly shrugged off a new 1% tax on stock buybacks as just part of the cost of doing business. According to some experts, a proposed 4% tax might push companies to reshape their buyback strategies as a result of the proposed tax.

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Several companies have now begun considering how their share repurchase policies might change if the rate increase passes, including Overstock.com Inc., Kinder Morgan Inc., and Leidos Holdings Inc. If the rate increase passes, executives from all of these companies may have to alter their share repurchase policies. Among the strategies that are being considered is the possibility of repurchasing shares at a lower price in order to limit the impact of taxes, or to instead focus on paying dividends to shareholders in order to return capital to them. 

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Over the past few months, U.S. companies have spent hundreds of billions of dollars on share repurchases, which are often seen by businesses as a good use of capital because share repurchases reduce the number of shares a company holds, thereby increasing stock prices. It is anticipated that stocks will be bought back for the first time in a calendar year by companies in the S&P 500 in 2023, despite the 1% tax, according to S&P Dow Jones Indices, despite the levy.

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Just a little over a month after the 1% tax took effect on Jan. 1, President Biden proposed in his State of the Union address that the rate be raised to 4% in order to encourage long-term investments by companies instead of rewarding shareholders and executives. There have been efforts by a group of Senate Democrats to follow up with another bill that seeks to raise the tax on certain buybacks from 1% to 4%, a proposal that faces hurdles in the divided Congress due to its frequency of passage. 

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Among other things, Leidos Holdings, an information-technology and engineering services company, may shift some of its buyback spendings to dividends if the tax increases, according to CEO Roger Krone, who steps down in May. A repurchase of up to 20 million shares was authorized by the board of the Reston, Va.-based company in February of last year. 

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It is estimated that Leidos returned $741 million to its shareholders during the fiscal year that ended Dec. 30, including $199 million as part of its regular dividend program and $542 million in share repurchases. It was Mr. Krone's opinion that even with a 1% tax on stock buybacks, stock buybacks are still the most preferred way to return cash to shareholders, according to a conference he attended in February.

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“Perhaps everyone within the industry will do more dividends or special dividends if the president gets us 4%,” he concluded, “if the president gets us 4%.” 

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In addition to the recent attention that has been paid to buybacks, the $53 billion Chips Act has also been a major subject of discussion. The U.S. government has begun to outline how it plans to award chip-manufacturing subsidies under the Chips Act, which aims to promote the domestic manufacturing of semiconductors in the country, and added this week that those receiving the funds will not be allowed to engage in buyback activities. 

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During this year's annual letter to shareholders of Berkshire Hathaway Inc., Warren Buffett used the opportunity to mordantly defend his company's buyback program. His letter to shareholders, written on February 25, states that Berkshire and the publicly traded companies it owns have benefited investors as a result of stock repurchases. "When someone tells you that repurchases are harmful to shareholders or to the country, or that they are particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue," he wrote. 

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The 1% tax applies only to net buybacks. In other words, if total shares are repurchased minus new shares issued during the year, there will be a 1% tax on net buybacks. This was a last-minute addition to last year's climate, health, and tax law. The Joint Committee on Taxation has estimated the tax would raise $74 billion over the next decade, and had it been in effect in 2021, the S&P 500 companies would have contributed roughly $8.4 billion as a result of the tax. 

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As of the end of the fourth quarter, S&P 500 companies had spent about $189 billion on stock buybacks, up 2% from the third quarter and down 18.2% from a year ago, according to preliminary data from S&P Dow Jones Indices, a unit of S&P Global Inc. that specializes in rating companies. S&P Dow Jones Indices senior index analyst Howard Silverblatt estimates that the index companies would have paid roughly $2 billion in taxes in the fourth quarter and lost about 0.48% in operating income had the levy been in place.

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“Payments are annoying, especially when you're counting every penny, but it won't stop you," Mr. Silverblatt said of the 1% tax on share repurchases.

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If the proposed 4% tax were to pass, it would bring the S&P 500 companies' tax bill to nearly $6.9 billion if it would be imposed on net buybacks, according to Mr. Silverblatt. Increasing the tax rate to around 2%, for example, could gain the support required in Congress if it is a moderate increase, according to him. A 2% tax rate would have resulted in companies paying around $3.4 billion in taxes in the fourth quarter, according to him. At a rate of 3%, this figure goes up to about $5.2 billion, which is a rate of 8%. 

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There is a good chance that companies would start reassessing their buyback activities if the tax was raised to between 2.5% and 2.75%, Mr. Silverblatt said. The company will then be able to push some of that money into dividends, though not dollar for dollar, he said. 

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It has been found that companies tend to prefer buybacks over dividends when it comes to dividends. For instance, share repurchases tend not to bind the company to continue buying shares, and also offer flexibility when it comes to the timing of the purchase. Dividends, on the other hand, come with an expectation that they will be paid in the future. For many shareholders, dividends are also taxable, whereas buybacks—until this year—were generally not considered to be taxable events, while dividends are. 

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In the event that the tax rate increases, Overstock will consider paying dividends, according to its Chief Executive Jonathan Johnson. A $100 million buyback program was announced by the Midvale, Utah-based company in August 2021 that will run until December 31, 2023. Overstock bought back $20 million in shares during the final quarter of last year, leaving around $19.9 million remaining under their current authorization to buy back shares.

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Despite the fact that Johnson says that a 1% excise tax is a "toll," it is not a meaningful one. “But if the tax is raised high enough if the toll is high enough, it may wind up coming back in dividends,” he said. Mr. Johnson noted that the company has not yet determined how high the tax would have to climb in order to have an effect on the company's buyback actions. 

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Kinder Morgan, a provider of energy infrastructure services, told Reuters that a higher tax would mean lower stock prices are needed at the time of share repurchases if a higher tax is implemented, according to Chief Financial Officer David Michels.

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A limit of $2 billion had previously been set for Kinder Morgan's share repurchase program (which is now $3 billion), but in January the company's board increased that limit to $3 billion. Founded in Houston in July 2017, the company has repurchased around $943 million of its shares since it authorized the program. Mr. Michels says that share repurchases are a discretionary use of excess capital for the company. It is only when we have an attractive repurchase price that we would consider share repurchases, according to the CFO.

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Mr. Michels says that at 1%, the excise tax may play a role in buyback decisions, but is not an important part of them. Regardless of the increase in excise taxes on buybacks, our approach will generally remain the same, even though even lower market prices would be required to execute stock repurchases."