The following article is adapted and reprinted from the M&A Tax Report, Vol. 11, No. 8, March 2003, Panel Publishers, New York, NY.
STOCK BUYBACKS: REPORTING OBLIGATIONS?
By Robert W. Wood
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.
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.
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.
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.
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 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.
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?
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.
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.
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.
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, The M&A Tax Report (March 2003), p. 4.