Description and Purpose
Section 1244 of the Internal Revenue Code (IRC) allows investors in small business corporations to receive special tax treatment. It offers the opportunity to claim ordinary losses on their investment, up to certain limits, rather than being limited to capital losses. This provision was created to encourage investments in small businesses by providing tax benefits to mitigate the risks involved.
Eligibility Criteria
Company Requirements
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Small Business Corporation: The company issuing the stock must qualify as a small business corporation. For this purpose, the corporation’s aggregate amount of money and other property received for stock must not exceed $1,000,000.
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Active Business Requirement: The corporation must derive more than 50% of its receipts from active business operations, not from passive income like rents, royalties, or investment income.
Investor Requirements
- Stockholder: The investor must be an individual or a partnership.
- Holding Period: The stock must be issued directly by the corporation as part of an original issue, not acquired from another shareholder.
Tax Deduction Limits and Benefits
Deduction Limits
Investors are allowed to deduct up to:
- $50,000 in any taxable year if filing as an individual.
- $100,000 if filing a joint return with a spouse.
Ordinary Loss vs. Capital Loss
- Ordinary Loss Treatment: Losses on Section 1244 stock can be deducted as ordinary losses, which can offset ordinary income. This is generally more advantageous compared to capital losses, which can only offset capital gains or up to $3,000 of ordinary income per year.
Example Calculation
Consider an investor who purchased Section 1244 stock for $60,000, and the stock becomes worthless:
- Single Filer: They would deduct $50,000 as an ordinary loss and the remaining $10,000 as a capital loss.
- Married Filing Jointly: They could choose to deduct up to $100,000 as an ordinary loss, covering the entire amount in this scenario.
Historical Context and Applicability
Legislative Background
Section 1244 was enacted as part of the Small Business Tax Revision Act of 1958. The initiative aimed to stimulate investment in small businesses, acknowledging the elevated risk and potential losses investors face.
Current Relevance
This provision remains significant for small businesses and their investors, offering a safety net that encourages entrepreneurship and investment.
Related Terms
- Ordinary Loss: An ordinary loss results from activities related to the taxpayer’s trade or business, sheltering regular income from taxation beyond capital loss limitations.
- Capital Loss: Capital losses occur from the sale or exchange of a capital asset and are used primarily to offset capital gains, with a limited deduction allowance against ordinary income.
- Small Business Corporation: A domestic corporation whose gross assets at the time of issuance do not exceed $1,000,000, among other criteria, qualifying it for Section 1244 benefits.
FAQs
What is the primary advantage of Section 1244 stock over other stock types?
Can corporations or trusts be eligible for Section 1244 stock ordinary loss treatment?
Does the $1,000,000 aggregate investment limit apply to all equity or only to stock?
References
- Internal Revenue Service, Publication 550: Investment Income and Expenses.
- IRC Section 1244: Details and Legal Guidelines.
Summary
Section 1244 stock provides a substantial tax benefit for investors willing to support small businesses by allowing them to claim ordinary losses up to $50,000 (or $100,000 for joint filers) on the disposition or worthlessness of stock. This provision reduces the inherent risk and encourages investment in small enterprises, fostering innovation and business growth.
