William Stromsem, CPA, J.D., Assistant Professor, George Washington University School of Business
In recent years, many corporations have been buying back their own stock, thereby reducing the number of outstanding shares and increasing the proportional ownership of the remaining shares. This trend could increase as lower corporate tax rates and repatriation of foreign earnings bring in more cash. In some cases, there has been a dramatic reduction in outstanding shares. Apple, for example, bought back shares to the extent that outstanding shares dropped from 6.6 billion in 2012 to 4.7 billion today. Cisco, Wells Fargo, Pepsi, Starbucks and McDonalds have had similarly dramatic reductions in the number of their shares. Buybacks, which were once illegal, are accelerating in frequency and amounts. (In 1982, the Securities and Exchange Commission passed Rule 10b-18, which created a legal process for buybacks.)
Some members of Congress have expressed a concern that many corporations may use the tax benefits from the Tax Cuts and Jobs Act (TCJA) to buy back their stock rather than for increased wages, capital formation or job creation. In response, various proposals are being floated on Capitol Hill. Senator Marco Rubio (R-FL) has stated that stock buybacks should be treated as if the remaining shareholders were given a dividend and chose to use it to purchase additional shares to increase their percentage ownership of the corporation. Other members of Congress believe that the business breaks in the TCJA should be used to create jobs and raise wages, not just to enrich shareholders. Senator Chuck Schumer (D-NY), for example, has expressed the view that before a corporation can benefit its remaining shareholders with a buyout, it should be required to give more benefits to employees, such as higher wages, health care insurance coverage and sick leave.
The analysis that a buyback is a tax-free distribution is somewhat overstated: if a corporation buys back shares, a tax on the capital gain is being paid currently by those whose shares are purchased, and the value of the remaining shares is not dramatically increased, because corporate assets are reduced by the cash being paid out to purchase the shares. Also, while the buyback may result in a deferred capital gain until the remaining shareholders sell their shares, this is like deferring tax by holding the cash at the corporate level rather than paying a dividend.
It is unlikely that Washington will be able to agree to do anything until possibly after the next elections. However, buybacks are regulated by government agencies other than the Internal Revenue Code, so a legislative change may not be required. Cash-rich companies that are considering a share buyback should be aware that there is a potential for less favorable tax treatment if the political climate changes.