IRC Section 1244 Stock: An Easy Way to Convert Capital Losses to Ordinary Losses
Although no one starts up a business with plans to fail or lose money, the success rate statistics for new businesses can be daunting. That's why Section 1244 stock should be on the mind of every new business owner who organizes their business as a C corporation.
Section 1244 stock is possible thanks to Section 1244 of the Internal Revenue Code. This is known as the small business stock provision, and was enacted to allow stockholders of domestic small business corporations to deduct losses incurred when they dispose of their small business stock as ordinary losses instead of capital losses.
The general rule is that any loss suffered by a stockholder upon liquidation of the company will be considered a capital loss. But, if the stock is Section 1244 stock, a part of the loss ($100,000 for husband and wife filing jointly, otherwise $50,000) will be treated as an ordinary loss. Since the loss is treated as ordinary, it can be used directly to offset the stockholder's investment income, passive income, wages, and self-employment income. In addition, because the use of the loss is accelerated, the tax advantage is much greater than if the loss is treated as capital.
Whether stock is Section 1244 stock depends on whether the requirements of IRC 1244 are met at the time the stock is originally issued. These requirements relate to (1) the corporation issuing the stock; (2) the stock itself; and (3) the stockholders of the corporation.
Being able to issue Section 1244 stock is one of the great tax benefits of organizing a business as a C corporation. Of course, you should consult with a knowledgeable Michigan business lawyer when setting up your corporation so that he or she can advise you on the requirements for issuing valid Section 1244 stock.
