What stock buybacks are, and how a new 1% tax affects your portfolio

The new 1% excise tax on corporate stock buybacks — a late addition to President Joe Biden‘s sweeping tax, health and climate package — adds a new levy to the controversial practice.

But there are mixed views on how it may affect investors.

The Inflation Reduction Act provision levies a 1% excise tax on the market value of net corporate shares repurchased starting in 2023.

When a profitable public company has excess cash, it can purchase shares of its own stock on the public market or make an offer to shareholders, known as a stock buyback or share repurchase.  

It’s a way of returning cash to shareholders, explained Amy Arnott, portfolio strategist at Morningstar, and more widely used than dividends, a portion of company profits regularly sent back to investors.

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If overall shares are reduced, stock buybacks may also boost earnings per share, one method of measuring a company’s financial performance.

However, critics have argued buybacks often come with the new issuance of stock options for executives and other employees. Adding new shares can negate some, or all, of share reduction benefits for regular investors from buybacks.

With low interest rates boosting profits and values, S&P 500 companies bought back a record $881.7 billion of their own stock 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 monsters,” with five companies — Apple, Google parent Alphabet, Facebook parent Meta, Microsoft and Bank of America — making up one-quarter of the dollar value of stock buybacks over the past year. 

While the full impact on the stock market isn’t yet known, experts have mixed opinions on how the provision may affect individual portfolios.

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

It’s estimated that a 1% tax on share repurchases may trigger a 1.5% increase in corporate dividend payouts, according to the Tax Policy Center.   

And increased dividends may have an unexpected impact, depending on where investors are holding these assets, said Alex Durante, federal tax economist at the Tax Foundation.

“People with taxable accounts may potentially be impacted,” he said.

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

The provision is expected to raise about $74 billion over the next decade, according to recent estimates from the Joint Committee on Taxation.

However, since the new law won’t kick in until Jan. 1, 2023, some experts predict companies will accelerate “tax-free” stock buybacks through 2022, especially with stock prices still well below previous values. 

General Motors on Friday announced it will resume and boost share repurchases to $5 billion, up from $3.3 billion previously left from the program. And Home Depot on Thursday announced a $15 billion share buyback program.