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Losses on the Sale of Small Business Stock (Section 1244)
According to statistics published by the American Bankruptcy
Institute, there were an average of 59,765 business bankruptcies
per year in the United States between 1980 and 2000.
As a result, a lot of people have lost most, if not all,
of their invested capital. Under the tax code, you are
only allowed to deduct $3,000 of net capital losses each
year. But there is an exception to these rules under Internal
Revenue code section 1244. This section offers relief
to individuals who suffer capital losses when they sell
stock of a qualifying small business.
Under section 1244, losses that would otherwise be treated
as capital losses are treated as ordinary losses. This
has several advantages to the individual:
- Ordinary losses are not limited to $3,000 per year.
Your ordinary losses can be fully deducted in the year
of the loss.
- Ordinary losses are not netted with capital gains
that are subject to a maximum tax rate of 20%. Therefore,
if you have capital gains in the same year you have
ordinary losses, you can still enjoy the capital gains
rates.
- Ordinary losses offset other sources of income that
is taxed at ordinary rates, which can be as high as
35% in 2003.
The maximum 1244 loss that can be taken in any year
is:
- $100,000 for married individuals filing a joint return;
- $50,000 for all others.
To qualify as a section 1244 small business stock there
are several requirements that must be met.
- The stock must come from a domestic corporation. Only
stock (including preferred stock) of a domestic corporation
can qualify as section 1244 stock. If the stock was
issued prior to July 19, 1994, the stock must be common
stock.
- The company must be small. Capital receipts of the
company can’t be over $1,000,000, including the
value of any stock previously issued. If the capital
received exceeds $1 million, the corporation must designate
which shares are considered 1244 stocks. If, in the
year of issue, the capital received goes over the $1
million mark, and the company fails to designate the
stock within the required time period, the IRS regulations
specify how to allocate the loss between 1244 stock
and non-1244 stock.
- You must have paid for the stock with money or other
property. The stock issued must be issued in exchange
for cash or other property. Stock issued in exchange
for other stocks doesn’t qualify, and stock issued
for services rendered doesn’t qualify either.
Also, special rules apply to the valuation and treatment
of property that was exchanged for the stock. If you
contribute property to the corporation, you should familiarize
yourself with these rules.
- Most of the company’s gross receipts must be
from operations. For a period of the corporation’s
most recent five years ending before the date of the
loss, gross receipts from royalties, rents, dividends,
interest, annuities, and sales or exchanges of stock
or securities must not exceed 50% of the receipts of
the company. If the company has been in business less
than five years, the testing period applies to all the
years the company has been in existence. This gross
receipts test does not apply, however, if during the
applicable period, the aggregated amount of deductions
exceeds the aggregate amount of gross income. To have
this exception apply, the company must be an operating
company; it can’t be an investment company.
- As owner of the 1244 stock, you must be an individual,
or a partner in a partnership, which holds 1244 stock.
- You must have acquired the stock after June 30, 1958.
- If the stock was acquired before November 7, 1978
the stock was issued under a written plan that met the
requirements of section 1244.
- You have held the stock continually as an individual,
or partnership, since the date the stock was issued.
If all of these requirements are met, you should report
the loss, up to the maximum limitation, on line 10 of
Form 4797. You should report any loss in excess of the
limit on Schedule D, Form 1040.
By Intuit Inc.
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