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Mike DiSabatino CPA

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Worthless Small Business Stock - A loss can be a Win?

Worthless Small Business Stock - A loss can be a Win?

Worthless Small Business Stock - A loss can be a Win?

Sometimes you need to close your corporation... I have seen to many businesses struggle with debts that are unbearable as circumstances change; a downward eceonomy, technology obsolesence or change in customer demographics.  Many owners fear the closure, as they do not know of the ability to salvage some tax dollars through the closure.

 

Internal Revenue Code Section 165(a) allows a deduction for losses incurred during the year and not compensated by insurance or otherwise. Deductible losses include investment securities, such as stocks or bonds, that become worthless during the taxable year. For an investment security which does not trade on an established exchange, insolvency of the issuing corporation is the best evidence of worthlessness. A company is insolvent if the amount of its liabilities exceeds the fair market value of its assets, or if it is unable to pay its debts as they come due.

Under Internal Revenue Code Section 165(g)(1), a loss from an investment security becoming worthless during the taxable year is a capital loss. Capital losses may be offset against capital gains. In addition, an individual taxpayer can deduct against ordinary income no more than $3,000 of capital losses in excess of capital gains realized during the taxable year. An individual taxpayer’s unused capital losses may be carried forward and treated as realized in future tax years indefinitely.

But... and here is the good part... if the taxpayer is an individual, and the worthless stock is Internal Revenue Code Section 1244 stock, then the taxpayer may treat up to $50,000 of the loss as ordinary (up to $100,000 of the loss in the case of a husband and wife filing a joint tax return). “Section 1244 stock” is stock in a domestic corporation if:

  1. at the time such stock was issued, such corporation was a “small business corporation,”
  2. such stock was issued by such corporation for money or other property (other than stock and securities), and
  3. such corporation, during its five most recent taxable years, derived more than 50% of its aggregate gross receipts from sources other than royalties, rents, dividends, interest, annuities, and sales or exchanges of securities.

A corporation is a small business corporation if the aggregate amount received by the corporation for its stock, or as a contribution to its capital, does not exceed $1,000,000.

If the old company has valuable assets which the taxpayer wishes to use in the new company, the taxpayer should have them appraised at forced sale value, and have the new company pay the old company that amount for them. Alternatively, the old company could file a chapter 7 bankruptcy case, and the new company could attempt to buy the assets from the bankruptcy trustee.

Successful implementation of this strategy will yield the taxpayer a loss deduction, ordinary or capital, for his cost basis in the abandoned company. If the abandoned company was effectively organized and operated as a corporation, and the taxpayer did not personally guarantee any of its debts, then the taxpayer will not be personally liable for any of the its debts.

Keep in mind the IRS may challenge whether the stock in the old company has become worthless, or the year in which the taxpayer claims it became worthless.

Please give us a call to discuss this or any of our other topics with you, so we can address your specific requirements.

DiSabatino CPA
Michael DiSabatino
651 Via Alondra Suite 715
Camarillo, CA 93012
Phone: 805-389-7300
ww.sharpcpa.com

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