STOCK BUYBACKS: REPORTING
OBLIGATIONS?
These days, the annual
flurry of Forms 1099 and other wondrous flimsy tax reporting forms has
just passed. Whew! It seems that every year this season gets more frenetic,
with reporting forms. For better or for worse, the IRS seems to be relying
on its matching program for at least a good part of its revenues.
And, as anyone who has
suffered a misreporting has doubtless found, once some kind of report gets
into the IRS system, it can be devilishly hard to get the error corrected.
All of that makes it appropriate to turn to what would seem to be a well-settled
(and frankly even pedestrian) issue: how does a company report stock buyback
(a/k/a redemption) payments? In general, of course, a sale or exchange
of securities would be reported on a Form 1099-B. Just to make things interesting,
let’s look at the appropriate tax reporting for a redemption made in kind
(a distribution of stock). Here is our factual assumption.
Bigco has made a distribution
of some of its assets (let’s say public company securities) in redemption
of some of Bigco’s own stock. Let’s assume that the Bigco shareholders
who are redeemed out in this way are completely redeemed out, so they no
longer own any equity interest in Bigco.
The question is how such
a transaction should be reported by Bigco to the redeemed shareholder.
Let’s assume that this payment qualifies as a redemption to the recipients
(rather than as dividends). Given the complex web of IRS Form 1099 reporting,
one would assume that this kind of occurrence would be addressed.
Of the many forms required
for reporting payments to the IRS, three forms, 1099-B, 1099-DIV and 1099-MISC,
seem to be the most applicable to report these redemption payments. However,
the instructions for each of those forms and the forms themselves are not
terribly helpful in determining how to handle the reporting of redemption
payments.
Form 1099-B
What about Bigco and its
redemption payment with distributed stock? Well, Bigco here would not appear
to be a broker, since it does not regularly redeem its own stock. In addition,
Bigco did not enter into a barter transaction with its stockholders, so
that description from the instructions and regulations also seems inapplicable.
As such, it does not appear that Form 1099-B is the appropriate form to
report the redemption payments to Bigco shareholders.
Form 1099-DIV
If the redemption distributions
are big enough (of sufficient magnitude in relation to Bigco), it may be
possible to argue that the redemption payments here were made in partial
liquidation. If Bigco distributed significant assets to its shareholders,
that treatment may apply. I.R.C. §302(e)(2). Of course, a payment
in partial liquidation might not be considered a dividend. I.R.C. §302(b)(4).
How does this affect tax reporting? Well, it is not clear that a payment
that may not be a dividend should be reported on Form 1099-DIV because
it may be considered a payment in partial liquidation. Yikes!
Form 1099-MISC
There is no listing —
in all of the copious types of payments that should be reported on a Form
1099-MISC — for how one goes about reporting payments made in redemption
of stock. There is an “other” category, but the instructions suggest reporting
payments such as prizes and awards and lawsuit recoveries in that category.
As such, Form 1099-MISC does not appear to be the appropriate form for
reporting the Bigco redemption payments.
What to Do?
The mechanics of reporting
here are a bit puzzling, but I would suggest reporting the payments on
Form 1099-B in this case. True, Bigco is not technically a “broker” effecting
a stock trade. Nonetheless, the redemption payments are analogous to a
stock trade or exchange transaction. In fact, I.R.C. §302 refers to
stock redemptions as an exchange transaction.
One result of an exchange
transaction is that taxpayer’s basis may offset the gross proceeds received
in the transaction in determining net gain or loss. Of the three forms
discussed above, only the 1099-B provides clearly that gross proceeds (rather
than net proceeds or income) are to be reported on the form. As such, there
is an argument for using Form 1099-B to report the Bigco redemption payments.
Reporting Penalties
Not unlike the web of
1099 requirements, there are several different 1099 (or other report) penalties.
Let’s cut out a whole category of them that we should not be concerned
with here, which deal solely with timing issues and accuracy problems.
There are penalties for late filing of 1099s and other reports. There are
also penalties for failure to correctly complete 1099s and other reports.
Putting these aside, the main penalties that should be considered are the
basic failure to file penalty, and the intentional failure to file penalty.
The latter is, at least in my experience, quite unlikely to be imposed.
Turning to the main penalty
for failures to issue required reports, the penalty is only $50 per failure.
That means that the penalty has serious teeth only when there has been
a mass or repetitive failure. The penalty seems primarily devised to hit
hard a company that has failed to issue a large number of Forms 1099 or
other reports. This $50 per failure penalty is obviously not much of a
significant threat where the question is if the payor must file one form
or not. Taxpayers will always want to make the right decision, but incurring
the wrath of a $50 penalty doesn’t seem too worrisome.
Notably, even this de
minimus $50 per failure penalty is subject to a reasonable cause exception.
The penalty for intentional
disregard of reporting requirements is obviously more serious, both in
its pejorative moniker, and in its amount. The penalty for intentional
disregard of the reporting requirements is 10% of the amount involved.
Thus, if a 1099 should be sent for $100,000, the penalty for intentional
disregard of this requirement would be $10,000. As with most other intentional
disregard penalties, evidence that good faith investigation of reporting
requirements and good faith interpretations were taken would seem to obviate
virtually all risk of the penalty’s imposition. The presence of this intentional
disregard penalty means that taxpayers certainly should not disregard the
reporting requirements willy nilly. However, I personally have seen a number
of cases of difficult reporting quandaries where judgments have to be made.
And, I’ve so far never yet seen the intentional disregard reporting penalty
imposed.
Stock Buybacks: Reporting
Obligations?, Vol. 11, No. 8, M&A Tax Report (March 2003), p. 4.
According to the instructions
for Form 1099-B, that form is to be used by brokers and barterers in broker
and barter transactions. The Form 1099-B instructions and Treasury Regulation
§1.6045-1 define a broker as any person (or business) that: 1) in
the ordinary course of their business effects sales made by others; 2)
regularly issues and retires their own debt; or 3) regularly redeems their
own stock. The instructions also state that a corporation that purchases
stock from its shareholders on an irregular basis is not a broker.
The instructions for
Form 1099-DIV require that the following must be reported on Form 1099-DIV:
payments of dividends (including capital gain dividends) to shareholders;
payments over $600 made as part of a liquidation; and payments where there
was backup withholding or foreign tax withholding. Section 302 and the
related Treasury Regulations state that stock redemptions that terminate
a shareholder’s interest are not considered dividends. Again, how do we
fare under this set of rules? In our set of assumed facts, the shareholders
that had their Bigco stock redeemed no longer hold any equity interest
in Bigco. As such, the redemption payments would not appear to be “dividends”
reportable on Form 1099-DIV.
Form 1099-MISC is generally
a catchall form for payments that must be reported but are not appropriate
for other forms. Unfortunately, even Form 1099-MISC has its limitations.
Literally dozens of examples of payments reportable on Form 1099-MISC are
provided in the form’s instructions, but they must fit in one of the categories
listed on the form.
Although it is not clear
what form should be used to report the redemption payments, it’s hard to
reach the conclusion that the redemption payments should not be reported.
Indeed, redemption payments are not excluded from the tax reporting requirements,
and prudence suggests reporting under the general reporting obligations
of I.R.C. §§6041 through 6043 and the related Treasury Regulations.
It is difficult to talk
about Form 1099 filing obligations without touching on the related subject
of reporting penalties. To be sure, payors (such as Bigco in the above
example) should comply with reporting obligations whether there are penalties
or not. Still, it is understandable that exactly how much a payor frets
over 1099 filing obligations is directly related to the likelihood of the
imposition of penalties, together wit the severity of those penalty when
and if they’re imposed.