What share buybacks are and how a new 1% tax will affect your portfolio

U.S. President Joe Biden gestures as he makes remarks on the Inflation Reduction Act of 2022 at the White House on July 28, 2022 in Washington.

Elisabeth Franz | Reuters

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

However, there are differing views on how this could affect investors.

The provision of the Inflation Reduction Act imposes a consumption tax of 1% on the market value of the repurchased net company shares from 2023.

This is how share buybacks work

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

It’s a way of giving cash back to shareholders, explained Amy Arnott, portfolio strategist at Morningstar, and is becoming more widespread than Dividends, a portion of company profits that are paid back to investors on a regular basis.

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When shares are reduced overall, share buybacks can also boost earnings per share, a way of measuring a company’s financial performance.

However, critics have argued that buybacks often coincide with the re-issuance of stock options for executives and other employees. The addition of new shares may negate some or all of the benefit of reducing shares to ordinary investors from repurchases.

“Buyback Monsters” are driving the trend

With low interest rates driving earnings and values ​​higher, S&P 500 companies repurchased a record $881.7 billion of their own stock in 2021, up from $519.8 billion in 2020, it said Data from S&P Global.

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 — accounting for a quarter of the dollar value of share buybacks last year.

How the 1% tax on share buybacks may affect investors

While the full impact on the stock market is yet to be known, pundits have mixed opinions on how the determination could affect individual portfolios.

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

It’s estimated that a 1% tax on share buybacks could trigger a 1.5% increase in corporate dividend payouts, the company said Tax Policy Center.

And increased dividends can have unexpected effects depending on where investors hold those assets, said Alex Durante, a federal tax economist with the Tax Foundation.

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

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

According to this, the provision should bring in about 74 billion US dollars over the next ten years current estimates by the Joint Tax Committee.

However, with the new law not taking effect until January 1, 2023, some experts predict companies will accelerate “tax-free” share buybacks into 2022, especially as share prices are still well below historical levels.

General Motors announced Friday it would resume stock buybacks, increasing it to $5 billion, up from $3.3 billion previously left over from the program. And Home Depot on Thursday announced a $15 billion stock repurchase program.

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