18 Oct 2018 / 11:56 GMT
01 Articles Overview
02 Business Planning, Benefits & Strategies
03 S Corporations and C Corporations
04 Estate Tax, Discussion
05 Non profit corporation
06 Schedule C, Unincorporated Businesses
07 Section 1244 Stock
08 Stock transaction tax rules For Day Traders
09 Tax Treaty Countries
10 Trademarks
11 USA, State Death taxes
Articles of Interest
Section 1244 Stock
 

 
  • Introduction


    Corporate stock is generally considered a capital asset in the hands of individual shareholders. As such, gains and losses from its sale, exchange, or worthlessness are usually treated as capital gains or losses. To diminish the inequitable tax treatment between losses from the ownership of corporate stock and losses from the ownership of unincorporated entities, Congress enacted IRC Sec. 1244. This provision allows certain shareholders to treat losses incurred from the sale, exchange, or worthlessness of qualified corporate stock as ordinary losses, and not as losses from the disposition of a capital asset.
     
    For stock to be considered Section 1244 stock, certain requirements must be met regarding the stock, the corporation, and the shareholders. Specific requirements must be met when the stock is issued, during the operation of the corporation, and the year of the loss.
     
  • Worthless Stock


    As a general rule, if a stock or security becomes worthless during the year, the holder is entitled to claim the loss as a deduction in the year in which it becomes wholly worthless [IRC Sec. 165(g)]. This loss is normally a capital loss, although, stockholders who acquire shares directly from certain smaller corporations qualify for ordinary loss treatment under IRC Sec. 1244.
     
    The Section 1244 ordinary loss deduction for any tax year cannot exceed $50,000 for a single filer or $100,000 on a joint return
     
  • Pass-Through Is Applied Before Worthless Stock Loss


    IRC Sec. 1367(b)(3) states that, the normal S corporation pass through rules of IRC. Sec. 1366 (allowing the use of losses and deductions from the S corporation in the individual tax return of the shareholder) is to be applied before any worthless stock loss. In this way, an S shareholder claims the losses from the corporation occurring during the year in the normal fashion, which in most cases will reduce the stock basis to zero if the corporation is actually worthless. Only after these deductions are made is worthless stock claimed for any remaining tax basis in the S corporation stock.
     
  • Section 1244 Stock Loss


    Under IRC Sec. 1244, a recognized loss on the sale, exchange, worthlessness, or other disposition of "Section 1244 Stock" is treated as an ordinary loss. If IRC Sec. 1244 does not apply, the loss is from the sale or exchange of a capital asset, and is limited to maximum annual deduction of $3,000.
     
    IRC Sec. 1244 refers to losses on "small business stock". Provisions referring to small business stock in the S corporation statutes have nothing to do with Section 1244 references to small business stock. The objectives and requirements for qualification of these two sections of the Code are entirely independent of each other, although the provisions of IRC Sec. 1244 apply to both S and C corporations.
     
    An individual who suffers a loss can claim ordinary rather than capital loss treatment under IRC Sec. 1244 if the following requirements are met:
     
    1. The owner of the stock is either an individual or partnership.
    2. The owner of the stock is the individual or the partnership to whom the stock was originally issued.
    3. The shareholder contributed money or property, other than stock or securities, in exchange for the stock.
    4. The stock was issued by a domestic corporation.
    5. If the stock was issued prior to July 19, 1984, it must be common stock.
    6. The stock is not convertible into other securities.
    7. The aggregate amount of money and property received by the corporation for its stock as a contribution to capital or paid-in-capital did not exceed $1 million.
    8. During the five years prior to the loss, the corporation did not derive more than 50% of its gross receipts from interest, dividends, rents, royalties, annuities, and sales of stocks and securities. This rule normally will not apply to S corporations because the S corporation election would have terminated under the three-year excess net passive income termination rule.
    9. If the stock was issued before November 17, 1978, a written plan adopting IRC Sec. 1244 must have been in place.
    10. The corporation and shareholders maintain records to show that a loss qualifies under IRC Sec. 1244.