Many banks to pay higher taxes under Inflation Reduction Act

Many banks are set to receive a bigger tax bill next year under the new Inflation Reduction Act, which raises tax rates for some larger U.S. corporations and slightly penalizes share buybacks.

The two provisions are estimated to raise some $296 billion in revenues over 10 years for the federal government, helping pay much of the tab for climate change investments that President Biden signed into law earlier this month.

Several large and regional banks may take a bigger share of the tax hit because they currently pay below the new 15% minimum corporate tax rate. The new minimum tax applies to any companies with at least $1 billion in average annual earnings over the past three years.

Bloomberg

The buyback provision, which charges a 1% excise tax on share repurchases, is more wide-ranging and would impact publicly traded banks of all sizes.

Two key Democrats who have sought a buyback tax — Senate Banking Committee Chair Sherrod Brown of Ohio and Senate Finance Committee Chair Ron Wyden of Oregon — have pitched it as an incentive for companies to boost their investments and wages rather than making payouts to shareholders.

But experts are skeptical that a 1% tax is large enough to achieve that goal. They say that the new tax may make dividends, which are another way to distribute excess capital, slightly more attractive, but it won't meaningfully change the landscape.

The tax will likely curtail buybacks "very little," but it is "definitely not going to decrease payments to shareholders overall," said Northwestern University finance professor Phillip Braun.

Below is a breakdown of the two provisions' impact on banks.

Buyback tax

The 1% buyback tax, which will kick in next year, applies to any company whose share repurchases are above $1 million a year. That amount could capture many publicly traded community banks in addition to large banks.

The banking industry bought back roughly $75 billion in common shares last year, led by Bank of America, JPMorgan Chase, Citigroup and Truist Financial, according to S&P Global Market Intelligence data.

The buyback tax may also apply to companies' preferred stock redemptions and potentially other types of transactions, according to a client alert from the law firm Davis Polk.

But Braun and other experts don't expect the new tax will lead to a significant drop-off in stock buybacks. They note that repurchases still contain tax advantages over distributing excess capital through dividends.

"If the scales were tilted towards repurchases in the past, they're a little bit less tilted towards repurchases now," said Alice Bonaimé, a University of Arizona finance professor whose research focuses on corporate payout policies. But she said a 1% tax is too small to "drastically alter corporate behavior."

Another advantage is that buybacks are more flexible than dividends, she added, since companies can reduce buybacks without major pushback from shareholders, while a dividend cut can send alarm signals about a company's health.

"Once you initiate a dividend, investors expect dividends to continue pretty much forever," Bonaimé said. "If you cut the dividend, you're heavily punished by the market."

Those dynamics are evident in banks' capital payouts this year. 

Banks have tempered their buyback programs in 2022, with some $12.8 billion in buybacks during the first quarter, down from $13.5 billion a year earlier, according to S&P Global Market Intelligence. In July, JPMorgan, the country's largest bank by assets, announced a temporary suspension of its buyback program to meet higher capital requirements after the Federal Reserve's most recent stress tests.

But rather than cutting their dividends, large and regional banks are either keeping them flat or even increasing them.

"Shareholders really dislike it when they decrease their dividends," Braun said, though he noted that one-off "special dividends" may become slightly more attractive and do not carry that same risk.

Corporate minimum tax

The new 15% minimum corporate tax targets companies whose effective tax rates are currently below that threshold, though it would also allow for some wiggle room through tax credits and deductions.

Because of those factors, a definitive list of companies that will be affected is tough to gather. But some analyses suggest certain large and regional banks could see a tax hike.

A Washington Post analysis of Calcbench data found that Bank of America, U.S. Bancorp, Truist Financial, KeyCorp, M&T Bank, Regions Financial and Huntington Bancshares may be impacted by the new minimum based on their tax rates from 2019 to 2021.

Overall, 83 companies in the S&P 500 could be hit with higher taxes, including Amazon, Verizon, AT&T and General Motors, according to the newspaper's analysis.

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A separate Morgan Stanley analysis — which factored in the impact of tax credits, pension adjustments and other adjustments — found that 70 to 100 companies may be hit with higher taxes in any given year.

In a research note last week, the Morgan Stanley analysts flagged Comerica, Wells Fargo, PNC Financial Services Group, American Express, Bank of New York Mellon, First Republic Bank, Sallie Mae, First Horizon Corp. and Western Alliance Bancorp. as other banks that may be affected.

The Morgan Stanley analysis did not identify Bank of America or Huntington as companies that could face higher taxes, though it noted that the full picture will be uncertain until more regulatory details emerge.

If the difference in taxes is large enough, it does limit those banks' "profitability a little bit and it's definitely a headwind" for them next year, said Kyle Sanders, a senior equity research strategist at Edward Jones who covers the banking industry.