Starting a small business can be a risky undertaking and Internal Revenue Code Section 1244 provides special tax treatment to the disposition of certain qualifying stock of small businesses. It essentially allows losses up to $50,000 ($100,000 for married taxpayers filing jointly) to be subject to the more favorable ordinary loss treatment, all deductible in the year of the loss rather than being treated as a capital loss limited to a per year loss of $3,000 ($1,500 for married taxpayers filing separate). In addition, 1244 stock losses are allowed for NOL purposes without being limited by non-business income.
Congress originally created this benefit to encourage investment in small business enterprises. It may also be a factor in determining choice of entity when originally initiating a business. In addition to the benefits provided by Sec 1244, another part of the Internal Revenue Code, Sec 1202, allows gain from C corporation stock to be excluded from income where the aggregate gross assets of the corporation immediately after the issuance (determined by considering amounts received in the issuance) does not exceed $50 Million, the corporation meets an active business requirement, and the stock is held more than 5 years. The maximum excludable gain under Sec 1202 can’t exceed $10 million ($5 million, if married separate). For additional information related to the Sec 1202 gain exclusion give this office a call.
1244 Stock – In general the term 1244 stock means stock in a domestic corporation if at the time such stock is issued:
- Such corporation was a small business corporation,
- The stock was issued by a small business corporation for money or other property (other than stock and securities), and
- During the corporation’s 5 most recent taxable years ending before the date of the stock loss, derived more than 50% of its aggregate gross receipts from sources other than royalties, rents, dividends, interests, annuities, and sales or exchanges of stocks or securities.
Small Business Corporation Defined – A corporation is treated as a small business corporation if the aggregate amount of money and other property received by the corporation for stock, as a contribution to capital, and as paid-in surplus, does not exceed $1,000,000. The determination under the preceding sentence is made as of the time of the issuance of the stock in question but also includes amounts received for such stock and for all stock previously issued.
The losses are reported by the individual stockholder; however, individual stockholders do not include trusts or estates.
Section 1244 does not apply to any contributions made after the initial shares are issued unless the shares were authorized, but not issued. Section 1244 stock should be issued pursuant to a written corporate resolution.
Taxpayers taking advantage of the Section 1244 stock rules should document the factors that allow them to qualify. This could include corporate minutes and resolutions, accounting and bank records, and even operational records.
If you need additional information related to 1244 stock, please give this office a call.