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socrateaser
socrateaser, Attorney
Category: Business Law
Satisfied Customers: 37972
Experience:  Retired (mostly)
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Hi, I am shutting down a C-Corp, of which I am a major shareholder.

Resolved Question:

Hi,

I am shutting down a C-Corp, of which I am a major shareholder. I would like to deduct (on my personal tex returns) the loss sustained from my original investment in the Company. My partner and I originally formed the Company as an LLC and we each invested $5,000 in exchange for 50% of the shares. We later converted to an S-Corp and exchanged those LLC shares for shares in the Corporation. We then took a venture capital investment, and converted the Company to a C-Corp. It is my understanding, that in order to personally deduct your investment in a failed/dissolved C-Corp, you must have made an investment of money or property in the Corporation on the day it was formed, in exchange for shares. If so, it appears that we do not qualify for this tax relief. Is that correct? Is there any way for me to deduct this loss on my personal tax returns?

Thank you!
Submitted: 4 years ago.
Category: Business Law
Expert:  socrateaser replied 4 years ago.
An individual may take an ordinary loss deduction for a loss sustained on the sale, exchange, or worthlessness of small business stock (IRC 1244 stock), even if the stock is a capital asset in the taxpayer's hands. The maximum amount deductible as an ordinary loss in any tax year is $50,000 ($100,000 if married, filing jointly). Any loss is treated as a loss from a trade or business of the taxpayer in computing its net operating loss (NOL) for the year. Any loss that the taxpayer has from Sec. 1244 stock in excess of the dollar limits is treated as a capital loss.

To qualify as Sec. 1244 stock, it must be stock of a domestic corporation (including preferred stock) issued after Nov. 6, 1978, and:

1. The stock must have been issued to the taxpayer or a partnership in which the taxpayer was a partner at the time in exchange for money or property other than stock or securities;

2. The issuing corporation must be a small business corporation, i.e., at the time that the stock was issued, the total amount of money and other property received by the corporation as a contribution to capital and as a paid-in surplus must not exceed $1,000,000;

3. During the corporation's five most recent tax years ending before the date that the stock is sold by the individual, more than 50% of the corporation's gross receipts must have been derived from sources other than royalties, rents, dividends, interest, annuities and gains from the sales of securities.

Hope this helps.


And, if you need to contact me again, please put my user id on the title line of your question (“ToCustomerrdquo;), and the system will send me an alert. Thanks!

Customer: replied 4 years ago.
Relist: Other.
This was just a blatant copy/paste of what I have already found just through a web search. I need an answer that is specific to my situation.
Expert:  socrateaser replied 4 years ago.
There was no blatant copy from any internet source. My answer was extracted from an expensive, subscription tax research database.

You may have found something similar on the internet -- however, if my answer mirrors what someone else may have written, it's only because the tax law "is what it is," so there isn't a lot of room for interpretation. Every competent professional will provide you with the same answer. If you get something that does not mirror what I wrote, that's when you start worrying, because the proponent probably doesn't know what he's/she's talking about.

That said, you asked:

It is my understanding, that in order to personally deduct your investment in a failed/dissolved C-Corp, you must have made an investment of money or property in the Corporation on the day it was formed, in exchange for shares.

A: This is false. The fact that the investment was made on the date of corporate formation is irrelevant.

If so, it appears that we do not qualify for this tax relief. Is that correct?

A: In my opinion, you do not qualify for tax relief, not because your didn't exchange the investment for shares on the date of corporate formation (which as previously mentioned, is irrelevant), but rather because you may have exchanged LLC "shares" for shares of the corporation, and the tax law specifically excludes such exchanges. You must have exchanged money or property "other" than stock or securities.

Legally, an LLC cannot issue "shares," because it's not a corporation. So, you could make an argument that your "interest" in the LLC which was exchanged for corporate shares is, in fact, "other" property, not within the scope of the IRC 1244(c)(1)(B) limitation on investment type. Since this issue has never been litigated to my knowledge, the IRS may decide to challenge your deduction, or accept it, or perhaps you will never be audited. Wearing my conservative hat, I would say you're going to lose the argument; wearing my aggressive hat, I would say that maybe it's worth the risk ($50,000/$100,000) in deductions is a lot of money.

Ultimately, you will have to make the call, because you're in the gray area of tax law with your contemplated deduction.

Is there any way for me to deduct this loss on my personal tax returns?


A: The only other way to deduct the loss is as a standard capital loss, subject to the $3,000 per year maximum (with carryforwards to future years, until the loss is completely extinguished).

Hope this helps.


And, if you need to contact me again, please put my user id on the title line of your question (“ToCustomerrdquo;), and the system will send me an alert. Thanks!

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