How to Treat Income From a Stock Buyback

The tax treatment of share buybacks varies for individuals and corporations.

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Corporations repurchase their shares for a variety of reasons, including to reduce dilution, increase earnings per share for remaining shareholders, and consolidate control back in the hands of directors and a few select stockholders. If shares are substantially undervalued in the market, the directors may actually take the company private again by buying back all the floating shares. This has specific tax consequences for shareholders but generally not so much for the corporation.

Capital Gains Tax

If you are a shareholder, the Internal Revenue Service will charge a capital gains tax on any shares you sell at a profit. The amount of tax depends on your income tax bracket and the length of time you held the stock. If you held the stock for less than 12 months, the short-term capital gains tax applies, and you will be taxed on any profits at ordinary income tax rates. If you held the stock for more than 12 months, then more favorable long-term capital gains tax rates apply. As of July 2012, the maximum long-term gains rate is 15 percent, though the top rate was slated to increase to 20 percent as of 2013, barring congressional intervention.

Tax Treatment for Corporations

From the corporation's point of view, share buybacks are generally not taxable events. Rather, they are governed under Internal Revenue Code Section 1032, which stipulates that the corporation pays no tax on any gains, nor may it deduct any losses. Do not report either gains or losses on your IRS Form 1120 corporate income tax return.

Tax Harvesting

If you take advantage of a share buyback program and sell shares back to the company at a profit, you may be able to manage your exposure to capital gains taxes by selling other securities or assets in your portfolio at a loss. The IRS nets out gains against losses and charges capital gains taxes only on the difference.

Exception for Corporations

If the corporation buys back stock with appreciated noncash property (i.e., securities, real estate, automobiles, inventory, livestock) then the IRS may assess capital gains taxes on the transaction. The tax applies to any profits on the property or assets sold. From the IRS's point of view, the transaction is equivalent to the corporation selling the assets for cash and then using the cash to buy back the shares. However, if the assets have declined in value, rather than appreciated, the corporation is not generally entitled to claim a capital loss on assets other than cash used to buy back shares.