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What stock buybacks are, and the way a recent 1% tax affects your portfolio

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

Elizabeth Frantz | Reuters

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

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

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

How stock buybacks work

When a profitable public company has excess money, it could actually purchase shares of its own stock on the general public market or make a suggestion to shareholders, generally known as a stock buyback or share repurchase.  

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

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If overall shares are reduced, stock buybacks may boost earnings per share, one approach to measuring an organization’s financial performance.

Nevertheless, critics have argued buybacks often include the brand new issuance of stock options for executives and other employees. Adding recent shares can negate some, or all, of share reduction advantages for normal investors from buybacks.

‘Buyback monsters’ drive the trend

With low rates of interest boosting profits and values, S&P 500 firms bought back a record $881.7 billion of their very own stock in 2021, up from $519.8 billion in 2020, in line with S&P Global data.

A major percentage comes from a handful of so-called “buyback monsters,” with five firms — 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 yr. 

How the 1% tax on stock buybacks may affect investors

While the complete impact on the stock market is not yet known, experts have mixed opinions on how the supply may affect individual portfolios.

“I do not think it must have a significant impact on investors,” Arnott said. But on the margins, firms with excess money could also be “barely 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, in line with the Tax Policy Center.   

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

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

After all, the shift from buybacks to dividends may change the expected tax revenue, Durante added.

The availability is anticipated to lift about $74 billion over the following decade, in line with recent estimates from the Joint Committee on Taxation.

Nevertheless, for the reason that recent law won’t kick in until Jan. 1, 2023, some experts predict firms will speed up “tax-free” stock buybacks through 2022, especially with stock prices still well below previous values. 

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

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