There's a new 1% tax on share buybacks - here's what it means for your portfolio

There’s a new 1% tax on share buybacks – here’s what it means for your portfolio

US President Joe Biden gestures as he comments on the Inflation Reduction Act of 2022 at the White House in Washington, July 28, 2022.

Elizabeth Frantz | Reuters

The new 1% tax on company share buybacks — a belated addition to President Joe Biden’s sweeping tax, health and climate package — adds another levy to the controversial practice.

But there are mixed opinions about how this could affect investors.

The provision of the Inflation Reduction Act will impose a 1% excise tax on the market value of repurchased company shares from 2023.

How share buybacks work

When a profitable publicly traded company has excess cash, it can buy its own shares in the public market or make an offer to shareholders, also known as share buybacks or share buybacks.

It’s a way to give cash back to shareholders, explains Amy Arnott, portfolio strategist at Morningstar, and used more than dividends, some of corporate profits are regularly sent back to investors.

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If the total number of shares is reduced, share buybacks can also increase earnings per share, a method of measuring a company’s financial performance.

However, critics have argued that buybacks often involve the new issuance of stock options for executives and other employees. Adding new shares may negate some or all of the share reduction benefits for regular investors through redemptions.

‘Buyback monsters’ are driving the trend

With low interest rates boosting earnings and values, S&P 500 companies bought a record $881.7 billion worth of treasury shares in 2021, up from $519.8 billion in 2020, according to S&P Global data.

A significant percentage comes from a handful of so-called “buyback samples,” where five companies — Apple, Google parent Alphabet, Facebook parent Meta, Microsoft and Bank of America — accounted for a quarter of the dollar value of share buybacks over the past year.

How the 1% tax on share buybacks could affect investors?

While the full impact on the stock market is not yet known, experts have mixed opinions about how the determination could affect individual portfolios.

“I don’t think it should have a big impact on investors,” Arnott said. But on the ballpark, companies with excess cash may be “slightly more likely” to pay dividends than buy back shares, she said.

According to the Tax Policy Center, a 1% tax on share buybacks is estimated to result in a 1.5% increase in corporate dividend payments.

And higher dividends can have an unexpected impact depending on where investors hold these assets, said Alex Durante, federal tax economist at the Tax Foundation.

“People with taxable accounts could potentially be affected,” he said.

Of course, the shift from buybacks to dividends could also change expected tax revenues, Durante added.

According to recent estimates from the Joint Committee on Taxation, the provision is expected to generate approximately $74 billion over the next ten years.

However, because the new law won’t go into effect until January 1, 2023, some experts predict that companies will accelerate “tax-free” share buybacks through 2022, especially with stock prices still well below previous values.

General Motors announced Friday that it will resume share buybacks and increase it to $5 billion, up from $3.3 billion previously left over from the program. And Home Depot announced a $15 billion share repurchase program Thursday.

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