Section 1244 Stock gives qualifying shareholders an important tax advantage when a small corporation suffers losses or goes out of business.
Normally, a small corporation shareholder’s loss from the sale or exchange of their stock is considered a capital loss and must be used to offset the amount of any capital gains they may have had during the year. If they had no capital gains, the loss can then be used to offset ordinary income, but only to a limited extent.
Eligible small corporations are allowed to issue Section 1244 Stock, allowing for different tax treatment. A small corporation shareholder’s loss from the sale or exchange of Section 1244 Stock can be used to offset their ordinary income from other sources - up to $50,000 for an individual and $100,000 for a husband and wife who file a joint return.
In order for a corporation and its shareholders to be eligible for Section 1244 Stock, the following tests must be met:
1. The amount of money and/or property the corporation received for stock, a contribution to capital, and paid-in capital does not exceed $1,000,000.
2. A shareholder claiming a loss on the sale or exchange of Section 1244 Stock purchased the stock from the corporation as an original issue and is an individual or partnership.
3. The stock is either common stock or preferred stock.
4. The stock was paid for with money or property, not services or other stock or securities.
5. The corporation derived over 50% of its total gross receipts from sources other than rents, royalties, dividends, interest, annuities, or proceeds from sales or exchanges of securities either for the 5 years prior to the year in which the loss occurred or since the corporation’s inception, if it has not been in existence for 5 years.
When things go poorly for a small corporation, Section 1244 Stock can help ease the pain.