Section 1244 Stock: A Powerful Tax Break for Small Corporations

Section 1244 stock is a tax benefit many small business owners and early investors do not learn about until after something goes wrong. If you form a corporation and issue stock, Section 1244 can potentially help if the business fails or the stock becomes worthless. The main idea is simple: it may let an investor treat a qualifying stock loss as an ordinary loss instead of a capital loss, which can make the deduction much more useful.

Here is why that matters. Capital losses have limits. In general, if you lose money on stock, you may only be able to deduct $3,000 per year against regular income like wages, unless you have capital gains to offset. Section 1244 is different because it can allow up to $50,000 per year of loss to be treated as an ordinary loss, or up to $100,000 if married filing jointly. Any additional amount above those limits is typically treated as a capital loss. In other words, Section 1244 can let you deduct a much larger amount in the year the loss happens.

Not every corporation or stock issuance qualifies. To meet the Section 1244 requirements, the company must be a U.S. small business corporation, the stock must be issued for money or property, and the company must have received no more than $1 million in total capital at the time the stock was issued. The business also generally needs to earn more than half of its income from active business operations rather than passive investments. Because the benefit depends on how the stock was issued and documented, the planning needs to happen early.

For example, if someone invests $40,000 in a qualifying corporation and the business later fails, Section 1244 treatment could allow that investor to deduct the full $40,000 as an ordinary loss in that year, instead of being limited to $3,000 per year against ordinary income. If you are forming a corporation or bringing in investors and want to make sure your stock issuance and corporate records are set up correctly, Amerilawyer can help you structure it properly from the start.

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