By Miguel Reyna, CPA
Startup small businesses are risky even in good economic times, but with today’s uncertainty, Section 1244 stock provides an important benefit. If one of your clients experiences a loss from the sale of small business stock, you need to determine if the taxpayer qualifies under Section 1244 to treat the loss as ordinary and not subject to the normal limits on current deductibility that would otherwise apply to a net capital loss.
This benefit is limited to $50,000 if filing single and $100,000 if filing jointly in the year of the loss.
In order for the stock to qualify as Section 1244 stock, the following must be met:
- The stock must come from a domestic corporation, which also includes S corporations.
- The stock can only be issued from the corporation to the original owner to qualify and can only be purchased with money or property. Unfortunately, stock issued for services does not qualify.
- The stock issued and the cumulative money or property received by the corporation cannot exceed $1 million.
- The stock cannot include convertible stock whether it is common or preferred.
- The corporation must meet the gross-receipts test in the year of loss. The test is simply met if less than 50 percent of the company's gross receipts come from investment activities like dividends, interest, rents, royalties, stock, securities and annuities. Some exceptions do apply to this rule.
Section 1244 only applies to individual shareholders who are the original recipients of the stock. Other tax-related issues include analyzing when the allowed loss occurs and how it gets reported. There are special rules when Section 1244 stock is issued in exchange for property that has a built-in loss immediately before the exchange. The loss is reported on Form 4797, Sale of Business Property, and carried to Form 1040 as an ordinary loss.
Timing is critical in analyzing the changing tax nature of the applicable Section 1244 stock.
By taking advantage of Section 1244 ordinary losses, you can help your client receive substantial tax savings.
In the Treasury Inspector General for Tax Administration’s (TIGTA) Report on Results of the 2015 Filing Season, there were recurring concerns that some tax return preparers continue to potentially misuse the split-refund option by directing their clients’ tax refunds to their own bank accounts to recover preparer fees. It is unlawful to use Form 8888, Allocation of Refund (Including Savings Bond Purchases), to direct a portion of a refund to the tax return preparer in payment for services rendered or any other purpose. Such actions are subject to penalty.
In 2016 and subsequent years, partnership returns will be due a month earlier, the 15th of the third month after years end or March 15 for most (calendar-year) partnerships. Partnerships can request a six-month extension. S corporation returns will maintain their March 15 due date, but regular corporations get an extra month until April 15 for calendar-year companies. And the due date for the FinCEN Form 114, Report of Foreign Bank and Financial Accounts, for owners of foreign accounts with over $10,000 in value, has been moved up substantially from June 30 to April 15.
For clients with modified adjusted gross income (AGI plus tax-free foreign income) in excess of $250,000 ($200,000 if single), the 3.8 percent addition to their tax will apply to some or all of their investment income. (Technically, the lesser of the investment income or their modified AGI in excess of the threshold mentioned above.) For this purpose, investment income includes taxable interest, dividends, annuities, capital gains, passive income and royalties. Clients otherwise subject to the surtax can minimize it, or maybe even eliminate it, by considering the following steps that would reduce both modified AGI and investment income:
- investing in municipal bonds,
- recognizing capital losses to offset their capital gains,
- utilizing installment sales to spread out large gains, and
- participating in like-kind exchanges where appropriate.