Editor's Note: Learn from a panel of experts and entrepreneurs who have successfully financed their own ventures and are helping others do it at the Thought Leaders Live 2013 event May 29, in Long Beach, Calif. Event and ticket information can be found here.
If your S corporation has suffered losses due to economic hard times, you may be able to save a lot in taxes from these losses if you have Section 1244 stock. As you know, one of the advantages of an S corporation is that the firm's annual income or losses are passed through to shareholders. Gains are reflected on the individual shareholder's tax return, and losses are deductible.
One of the big advantages of having Section 1244 stock is that stockholders in an S corporation can claim an ordinary loss rather than a capital loss if the company runs into trouble, says Paul Gada, a tax analyst with CCH Business Owner's Toolkit, a division of Riverwoods, Illinois-based tax and business law information provider CCH Inc.
What's the advantage of claiming ordinary losses over capital losses? Individual stockholders are able to take more losses and thus a bigger deduction on their returns. The maximum excess capital loss that an individual taxpayer is allowed to deduct is $3,000 in any one year. Unused excess capital losses are carried forward and may be used to offset future capital gains.
Ordinary losses are more attractive from a tax standpoint than capital losses. In the year that qualifying Section 1244 stock becomes worthless or is sold at a loss, the taxpayer may deduct up to $50,000 of the loss as an ordinary loss rather than a capital loss. Those who are married and filing jointly may deduct up to $100,000. If the loss exceeds these limits, the excess will normally be treated as a capital loss.
In addition, taxpayers with qualifying Section 1244 losses may also benefit from the carry-back and carry-over provisions of the net operating loss rules. Unused Section 1244 losses may be carried back for up to two preceding tax years and forward for up to 20 years and can offset gross income in those years.
There are a number of qualifications you must meet to establish Section 1244 stock. For example, the S corporation issuing the stock must qualify as a small corporation at the time the stock is issued. In addition, the corporation must be actively involved in a trade or business, not just receiving rents or dividends.
As you see, Section 1244 stock provides a good insurance policy for owners, particularly when tough economic times hit. Check with your accountant to make sure you have this protection in place.
Great Falls, Virginia, writer Joan Szabo has reported on tax issues for 16 years.