[drelihan]

Buybacks are effectively taxed at the same rate as dividends, at least qualified dividends, just timing differs:

Simple case with a corporation worth $200 with two equal shareholders, who each paid $100 for their half of the company and are in 20% capital gains tax bracket, ignoring net investment tax of 3.8%:

Dividends:

Corporation pays $100 in qualified dividends, $50 to each shareholder. Each shareholder pays their capital gains tax rate on the $50. If that rate is 20% for each, then a total of $20 is collected by the US Treasury. Each shareholder then reinvests or spends the remaining $80 in the economy, while the government puts the $20 to work.

Buy Back Case:

Corporation buys back $100 of shares from 1 shareholder. No taxes were due there as there were no capital gains for shareholder 1. Shareholder 2 now owns 100% of the corporation, so their investment is now, all other thing equal, worth $200. When shareholder 2 sells, a bill for $20 is due ( $100 in capital gains x capital gains rate ). Shareholder 1 reinvests/spends $100 in economy, government gets no additional cash now, but will eventually when Shareholder 2 sells.

In the end, government gets the same $20 in tax. Benefits of the buy back are that investors are able to choose whether or not they want to cash out, whereas a dividend forces it on all investors. Downside is that government has to wait for the $20 in capital gains taxes. However, if shareholder 1 owed capital gains on the buy back ( perhaps they bought their share for $50, so would owe $10 in the $50 it made on the sale ), the government would get $10 from that sale + $20 down the road when shareholder 2 sold.

[cjlars]

Option three would be to not distribute cash through dividends or buy backs and reinvest directly in the business. In that case the net result and tax treatment is about the same as buying back shares. Trying to treat buy backs as a special case would just result in a defacto incentivization of conglomerates.

[drelihan]

I’d rather invest in just that company, one that can continue reinvesting profits in itself at attractive returns year in and out. I can sit back and let compounding work it’s magic ( although at some point in my life I will switch from a net producer to a net consumer and opt for cash ). In cases where a company does not need all the cash it generates to continue its growth or does not have growth prospects ( not necessarily a bad thing), then I’d rather have cash to invest more productively elsewhere.

[Sohcahtoa82]

> Corporation buys back $100 of shares from 1 shareholder. No taxes were due there as there were no capital gains for shareholder 1. Shareholder 2 now owns 100% of the corporation, so their investment is now, all other thing equal, worth $200.

Maybe I don't understand how stock works, but wouldn't shareholder 2 still own only 50%, with the corporation still owning 50% of itself?

[SmartJerry]

There is a disconnect here that needs to be clarified but you are actually part correct. The 'corporation' owns the shares, but shareholder 1 owns the corporation and thus it is his now. Shareholder 1 now owns 100% of the company but the company is worth 50% less because it spent half it's money on buybacks. So shareholder 1's value of ownership did not increase at all, only shareholder 1's % of ownership. Stock buybacks do not add value to a company and are not like a dividend at all. All they are is an indicator that the board thinks the shares are undervalued.

[Sohcahtoa82]

So...I know realistically, this isn't possible, but what if a corporation bought back every share except for one. Would that one lucky shareholder who probably bought his one share for $20 now own the entire corporation?

[SmartJerry]

yep

[NovemberWhiskey]

A stock buyback is not like the company is buying its own stock and holding it in a brokerage account.

Think about it like ... the opposite of an IPO. Instead of dividing up the firm into n shares and selling them to investors for cash; it's buying back n/m shares and effectively canceling them.

After the buy back, there are fewer shares of the company which are proportionately more valuable assuming the market capitalization has remained the same.

[Sohcahtoa82]

I looked up if a company can do the opposite - basically poof additional shares into existence and sell them - and found out they basically can and it's called stock dilution.

How is that legal? It doesn't make sense to me that if a share is worth x% of a company that said company can just decide "Nah, you actually now only own half of that" and sell more shares.

Fake edit: I googled "how is stock dilution legal" and found this [0] which explained it well and now it makes sense to me. The diluted stock might be a smaller % ownership, but since the company gained value because of money coming in, the dollar value of the shares stays the same.

[0] https://money.stackexchange.com/questions/58391/why-is-stock...

[drelihan]

No, the corporation retires the shares after the buyback. Total outstanding shares decrease. All remaining shareholders get a larger percent ownership of the corporation