What is Section 1244 ?
Section 1244 is the IRS provision enacted to allow shareholders of small business corporations (corporation’s equity may not exceed $1,000,000 at the time the stock was issued) to dispose their stock as an ordinary loss, which is likely to be a significant impact difference on a shareholder’s personal return from stock being treated as a capital asset and hence losses being deducted as capital losses, provided the qualifications and limits found below are met. If you own stock in a small “domestic corporation” (note: as LLCs are state created entities that are taxed differently than corporations the membership interest in the LLC cannot be treated as section 1244 stock as defined in Title 26) and you plan to dispose of it for a given tax year, certain qualification requirements must be met.
Meeting the Sec. 1244 Requirement
- The corporation must be a domestic small business corporation. A domestic corporation (including an S corporation) qualifies as a small business corporation if, when the stock is issued, its aggregate capital does not exceed $1,000,000.
- The stock must have been issued in exchange for money or property (other than stock and securities) and not inheritance or gift. Therefore, stock issued for services or other does not qualify under Sec. 1244.
- Only the original owner of the stock is entitled to claim a Sec. 1244 stock loss. If a partnership purchases Section 1244 stock of another company, and later disposes of the stock at a loss, the partnership entity may pass the resulting loss through to its partners. However, to be allowed to claim the loss as an ordinary loss instead of a capital loss, the partner must have been a partner when the stock was issued and have remained so until the time of the loss.
- Section 1244 is available only for losses sustained by shareholders who are individuals. Losses sustained on stock held by a corporation, trust or estate do not qualify for 1244 treatment. In limited cases, a partnership can qualify as a shareholder of 1244 stock. Generally, all transfers of 1244 stock by the shareholder, whether in a taxable or nontaxable transaction, whether by death, gift, sale or exchange revoke 1244 status.
Sec. 1244 Limits
Provided all of the requirements listed above are met, ordinary loss treatment for losses that arise for stock disposition are allowed. However, there are limits to the the amount of ordinary loss that an individual taxpayer may realize by reason of the small business stock provision. Any amount of Sec. 1244 loss in excess of this limitation is treated as a capital loss (there is no carry-forward). For losses incurred by unmarried individuals, the maximum amount they may claim as an ordinary loss for all losses sustained on Sec. 1244 stock in a taxable year is $50,000. For married individuals filing a joint return, up to $100,000 of the loss on Section 1244 stock may be claimed as an ordinary loss even if only one spouse owns the stock.
It is important that records are maintained for a minimum of five(5) years, and the records must show that the corporation’s stock qualifies as Section 1244 stock.
- The corporate minutes/by-laws, should make reference to the issuance of Section1244 stock.
- Keep records of gross receipts for the past five(5) years.
Understanding and unearthing all the caveats in the IRS tax code can be a daunting task for even the most sophisticated business owners and taxpayers, therefore it is always a good idea to consult a tax professional like those found at TaxPM who can help you review, and if necessary revise your tax filings.