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    1 Reply Latest reply on Apr 27, 2011 12:27 AM by AttorneyCPA

    Section 1244 Business Stock Tax Benefits

    AttorneyCPA Newbie

      I would like to add information about the potential tax benefit  of  investing in a small domestic corporation under section 1244 of the tax  code, which includes S Corporations. Essentially, section 1244 allows  losses sustained from the disposition of stocks in a small domestic  corporation to be deducted as ordinary losses instead of capital losses  for shareholders who hold these stocks. Under the tax code, capital  losses are subject to a $3,000 limit. Section 1244 allows you to  deduct the full ordinary loss for a small business stock if certain  requirements are met. You can deduct up to $50,000 as ordinary loss. Any amount over $50,000 will be treated as a capital loss subject to the $3,000 limit.


      It is not just a shareholder of a smal domestic corporation who sells his small business stock for a loss that can deduct. The owner of an S Corporation who is also an individual shareholder can deduct as well. For  example, if as the owner of the corporation, you sell your stock for a  loss or liquidate your business, you can deduct the full amount of your  loss (up to $50,000) against your ordinary income rather than just $3,000 maximum. 


      In order to qualify for this benefit, the corporation's aggregate  capital must not have exceeded $1,000,000 at the time the stock was  issued to the shareholders; the stock must have been issued in exchange  for cash or property, not as compensation or in exchange of services  or securities; and the corporation must pass the "gross receipts test."  The gross receipts test requires that             the corporation,  during the period of its five most recent years that ended before the              date the loss on its stock was sustained, derived more than  50% (half) of its gross receipts             from sources other than  passive investment income. Essentially, the small domestic corporation  must be actively engaged in a trade or business in order to qualify its  shareholders for this tax relief.


      Section 1244 is  only available for losses sustained by shareholders who are individuals.              Losses sustained on stock held by a corporation or a trust  do not qualify. The individual shareholder must have directly acquired  the stock by issuance from the domestic             small business  corporation and not by a subsequent transfer from a previous owner.


      This is a very brief overview of this complicated topic, but it  is worth noting that a serious investor or owner of stock in a small business should be aware of this potential tax benefit.