I was presenting to a group of angel investors recently on the topic of Section 1202 and Congress’s renewal of the 100% exclusion for investments made through the end of this tax year when the conversation turned to Section 1244 stock. The group had a bunch of questions on 1244 stock, and I thought I’d share the answers to some of those questions here.
First of All, What are the benefits of Section 1244?
If you are not familiar with Section 1244 of the Internal Revenue Code, it provides, for individuals, that losses on the sale or other taxable disposition of Section 1244 stock that would otherwise be treated as capital losses can be treated as an ordinary loss, subject to an annual limitation and certain additional requirements.
What is the Annual Limitation?
For any taxable year, the aggregate amount that can be treated as an ordinary loss on the sale or other taxable disposition of Section 1244 stock cannot exceed:
- $50,000, or
- $100,000 in the case of a husband and wife filing jointly.
What is Section 1244 Stock?
Section 1244 stock is stock in a domestic corporation if:
at the time of issuance the corporation was a “small business corporation;”
- the corporation issued the stock for money or other property (other than stock or securities); and
- the corporation, generally, during its 5 most recent taxable years ending before the date on which the loss on such stock was sustained, derived more than half of its aggregate gross receipts from sources other than royalties, rents, dividends, interests, annuities, and sales and exchanges of stock or securities.
What Is A Small Business Corporation?
For purposes of Section 1244, generally, a corporation is a small business corporation if the aggregate amount of money and other property received by the corporation for stock, as a contribution to capital, as paid-in surplus, does not exceed $1,000,000.
In the year the threshold is met, the corporation may designate (in accordance with a set procedure) which shares issued that year are Section 1244 stock. If no designation is made, the applicable Treasury Regulations generally pro-rate any remaining Section 1244 benefit among the shares issued that year.
Can Preferred Stock Be Section 1244 Stock?
Yes, preferred stock can be Section 1244 stock if it otherwise meets the requirements, but not if it was issued on or before January 18, 1984.
Congress amended Section 1244 in 1984 to remove the requirement that Section 1244 stock be common stock. There are still on the books Treasury Regulations which state that Section 1244 stock has to be common stock, but these Treasury Regulations pre-date the 1984 amendments.
In the General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, the Joint Committee on Taxation had this to say:
“The Congress believes that to encourage new venture capital, an ordinary loss deduction should be available on preferred stock, as well as common stock, of small business corporations.”