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This Alert addresses President Biden's FY 2025 Budget proposals, released March 11, 2024, with a focus on corporate M&A taxation, primarily those provisions arising under Subchapter C of the Code. Most of the proposals are the same as last year (i.e., the FY 2024 Budget proposal), with a modest tweak to the proposal involving the application of the stock buyback excise tax to foreign affiliates of an applicable foreign corporation, namely controlled foreign corporations (CFCs).

The FY 2025 budget proposals are explained in the Treasury Department's General Explanations of the Administration's Fiscal Year 2025 Revenue Proposals (i.e., the Green Book).

Stock repurchase excise tax

The stock repurchase excise tax of 1% currently applies to stock that a covered corporation repurchases during its tax year. This excise tax applies to the acquisition of stock of a foreign corporation by its specified affiliate (see Tax Alert 2023-0054).

The proposed budget would increase the stock repurchase excise tax to 4%, which is the same as last year's budget proposal. A new provision, however, would apply the excise tax to specified affiliates of applicable foreign corporations that are CFCs (generally corporations whose stock is majority owned by US shareholders). The provision would apply in the same manner that it applies to specified affiliates of applicable foreign corporations that are US corporations.

The proposal would apply to repurchases of stock after December 31, 2023.

Corporate distributions

The 2025 budget proposal addressing the IRC Sections 301 and 316 rules for characterizing distribution of property by a corporation to a shareholder is the same as last year's proposal, which would make several changes to the taxation of corporate distributions.

First, it would reduce earnings and profits by the basis in any distributed "high-basis" stock without considering basis adjustments from (1) actual or deemed dividend equivalent redemptions or (2) any series of distributions or transactions that have the purpose of creating and distributing high-basis stock (effective as of the date of enactment).

Second, it would treat so-called leveraged distributions from a corporation to its shareholders that otherwise would be treated as a recovery of basis as the receipt of a dividend directly from a related corporation that funded the distribution, to the extent funded "with a principal purpose of not treating the distribution as a dividend from the funding corporation" (effective for transactions occurring after December 31, 2024).

Third, it would treat a subsidiary's purchase of "hook stock" (stock of a direct or indirect corporate shareholder acquired by a subsidiary corporation in exchange for cash or other property issued by that corporation) as a deemed distribution from the purchasing subsidiary to the issuing corporation of the property used to purchase the hook stock (effective for transactions occurring after December 31, 2024).

Fourth, it would repeal the "boot-within-gain" limitation¹ for "dividend-equivalent' exchanges under IRC Section 356(a)(2) so the available pool of earnings and profits available for this purpose would "align" with the rules of IRC Section 316 (effective for transactions occurring after December 31, 2024).

Divisive reorganizations

IRC Sections 355 and 368(a)(1)(D)) currently exclude divisive reorganizations (e.g., spin-offs, split-offs or split-ups) from the general gain recognition rule. In a divisive reorganization, a parent corporation generally transfers property to a corporation it controls, in exchange for consideration comprised of controlled corporation stock and the assumption of liabilities, followed by a distribution of the controlled corporation stock to the parent company's shareholders. Variations on this model include the receipt of boot or controlled corporation debt securities that, together with controlled corporation stock, may be distributed to the parent company's creditors.

The budget proposal would make two changes. First, it would modify the two safe harbors for the tax-free transfer of "controlled boot" (money and other property but not debt of the corporation that the parent corporation controls) and securities to distributing creditors by creating an "excess monetization amount." This would cause the parent corporation to recognize gain dollar-for-dollar equal to the lesser of (1) its excess monetization amount or (2) the controlled boot that the parent corporation transfers to its creditors. In addition, the parent corporation would recognize gain if its excess monetization amount exceeded the controlled boot that the parent corporation transferred to its creditors.

Second, the controlled corporation must be adequately capitalized under IRC Section 355 as a result of the divisive reorganization and must continue to be economically viable.

Liquidation transactions

Current law includes exceptions to gain or loss recognition on corporate distributions for shareholders that own 80% or more of the distributing corporation's stock. In addition, IRC Section 267 generally defers losses on the sale or exchange of property in a controlled group or corporations until the property is transferred outside the group. These rules allow taxable liquidations to be structured in ways to recognize a loss.

The FY 2025 budget proposal would modify IRC Section 267, so it would deny loss recognition — both "inside" and "outside" losses — where the liquidating corporation's assets remain in the controlled group after liquidation. However, the Treasury Secretary would be authorized to allow the losses to be deferred, rather than denied, under IRC Section 267(f) "principles," and to address corporations that use controlled partnerships in these situations. The proposal would apply to distributions after the date of enactment.

Corporate affiliation test

The test for corporate control under IRC Section 368(c) currently requires a corporation to own stock comprising at least 80% of the total combined voting power of all classes of voting stock and at least 80% of the total number of shares of each class of outstanding nonvoting stock. The test for determining affiliation status in an "affiliated group" under IRC Section 1504(a)(1) requires the ownership of stock comprising at least 80% of the total voting power of a corporation's stock and at least 80% of its total value.

The FY 2025 budget proposal would conform the test for determining corporate control under IRC Section 368(c) with the test for determining whether a corporation is a member of an affiliated group under IRC Section 1504(a)(2). The term "control" would mean owning at least 80% of the total voting power and at least 80% of the total value of a corporation's stock (stock would not include preferred stock as defined in IRC Section 1504(a)(4)). The proposal would be effective for transactions occurring after December 31, 2024.

Implications

As noted, little has changed in the FY 2025 budget proposal as compared to the prior year, at least for purposes of proposed changes to Subchapter C of the Code. While some of the current-year proposals have effectively been recycled over the course of many years, others are relatively new. One of the newer, more notable proposals reflects the Administration's concern that various "monetization techniques" involving IRC Section 355 divisive reorganizations should be subject to the same adjusted basis limitation, although the precise mechanics envisioned by the "excess monetization amount" proposal are not clear.

Beyond Subchapter C, but also in the "relatively new" category: many taxpayers, especially foreign-parented groups, await further administrative guidance regarding the stock buyback excise tax. It is perhaps noteworthy that the latest budget proposal seeks to tighten the statutory rules addressing the buyback tax to such groups, i.e., to include not only domestic affiliates of a publicly traded "applicable foreign corporation," but also affiliates of the publicly traded foreign parent that are controlled foreign corporations. (For this purpose, controlled foreign corporations are described as corporations "whose stock is majority owned by U.S. shareholders," applying stock attribution rules.)