IRC § 1244 offers qualifying shareholders an important tax advantage when a small corporation suffers losses or goes out of business.
Normally, a shareholder’s loss from the sale or exchange of their stock is considered a capital loss and must be used to offset the amount of any capital gains the shareholder may have had during the year. If the shareholder had insufficient capital gains to offset the loss, the loss could then be used to offset up to $3,000 of the shareholder’s ordinary income incurred during the year.
However, certain stock held by shareholders of eligible small corporations is treated differently for federal income tax purposes under IRC § 1244. A small corporation shareholder’s loss from the sale or exchange of IRC § 1244 stock can be used to offset their ordinary income from other sources—up to $50,000 for an individual and $100,000 for a married couple filing a joint return.
In order for a corporation and its shareholders to be eligible for IRC § 1244 stock treatment, the following tests must be met: (1) the amount of money and/or property the corporation received for stock, a contribution to capital, and paid-in capital did not exceed $1,000,000 at the time of the issuance; (2) the shareholder purchased the stock from the corporation as an original issue and is an individual or partnership; (3) the stock is either common stock or preferred stock; (4) the stock was paid for with money or property, not services or other stock or securities; and (5) the corporation derived over 50% of its total gross receipts from sources other than rents, royalties, dividends, interest, annuities, or proceeds from sales or exchanges of securities either for the 5 years prior to the year in which the loss occurred or since the corporation’s inception, if it has not been in existence for 5 years.
The last test--that the corporation derived over 50% of its total gross receipts from sources other than rents, royalties, dividends, interest, annuities, or proceeds from sales or exchanges of securities--may be difficult to establish in your case since you do not have access to financials.
However, you may be able to force the private corporation to allow you to inspect the annual financials. According to Tatko v. Tatko Bros. Slate Co. Inc., a stockholder is entitled to inspect the books and records of a corporation for the purpose of determining the value of his stock. See Tatko v. Tatko Bros. Slate Co. Inc., 569 N.Y.S.2d 783 (3rd Dep't 1991). However, the stockholders right to inspect for the purpose of determining the value of his stock is limited to good faith requests. For instance, where a shareholders' agreement already provides another method of valuation, the request would be considered to be in bad faith and the board would not be required to allow the shareholder to access the financials. See People ex rel. Giles v. Klauder-Weldon Dyeing Mach. Co., 167 N.Y.S. 429 (3rd Dep't 1917).
I would suggest you hire an experienced, local corporate tax attorney to acquire the necessary documents and to analyze your eligibility for IRC 1244 loss treatment.
There's not much to add, after Matthew's answer. But all that being outlined for you, understand this: Identifying treatment for disposition of Sec. 1244 stock is indeed a "fact-based" analysis. By the language of the code, this was never meant to be a "do-it-yourself" analysis. So, please, find a local transactional tax attorney to review your facts. This is really not the forum to be advised on potential Sec 1244 application.
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Your biggest issue would be proving things such as your contribution was part of the first $1 million. This can be hard to prove with little information. You need to speak with a business attorney that can help you obtain the needed information if you plan to do this.
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