Sec 1244: Small Business Stock Sales
Section 1244 of the Internal Revenue Code, the small business stock provision, was
enacted to allow shareholders of domestic small business corporations to deduct
as ordinary losses, losses sustained when they dispose of their small business stock.
In order to receive this beneficial treatment, the Code prescribes specific requirements
for: (1) the corporation issuing the small business stock; (2) the stock itself;
and (3) the shareholders of the corporation.
- The corporation issuing the stock must qualify as a domestic small business corporation,
which generally means that it must be created under the laws of the United States
and that its aggregate capital must not exceed $1,000,000 at the time the §1244
stock is issued to its shareholders. The first taxable year in which the capital
of the corporation exceeds $1,000,000 is called the transitional year, and the corporation
must designate which shares issued that year qualify for §1244. For example, if
a newly formed corporation received $2,000,000 for its initial issue of stock, it
could designate up to $1,000,000 of its stock as qualified §1244 stock.
The corporation must also satisfy a gross receipts test. This test requires that
the corporation, during the period of its five most recent years ending before the
date the loss on its stock was sustained, derive more than 50% of its gross receipts
from sources other than passive investment income. The gross receipts test thereby
confines the tax relief provided by the small business stock provision to the stock
of corporations actively engaged in a trade or business. The gross receipts test
does not apply where, for the entire period for which gross receipts are measured,
the gross income of the corporation is less than the business deductions allowed
to the corporation by the Code.
The Code also imposes recordkeeping requirements on the corporation relative to
its §1244 stock. Among these is a requirement that the corporation designate, for
its transitional year, those of its outstanding shares that qualify for small business
- Common stock, and preferred stock issued after July 18, 1984, qualifies as §1244
stock. In order to qualify as §1244 stock, the stock must be issued, and the consideration
paid by the shareholder must consist of money or other property, not services. Stock
and other securities are not "other property" for this purpose. However, cancellation
of indebtedness may be sufficiently valid consideration.
- Section 1244 is available only for losses sustained by shareholders who are individuals.
Losses sustained on stock held by a corporation, trust or estate do not qualify
for §1244 treatment. Subject to very limited exceptions, the benefits of §1244 are
only available to individuals who acquire the stock by issuance from a domestic
small business corporation, and are not available to a subsequent transferee of
the stock. In some cases, a partnership can qualify as a shareholder of §1244 stock.
Generally, all transfers of §1244 stock by the shareholder, whether in a taxable
or nontaxable transaction, whether by death, gift, sale or exchange, terminate §1244
Once all of the requirements of §1244 stock are met, ordinary loss treatment for
losses on a sale or exchange of §1244 stock is permitted if the loss would otherwise
be treated as a capital loss. The amount of ordinary loss that an individual taxpayer
may realize by reason of the small business stock provision is subject to certain
limitations. Any amount of §1244 loss in excess of this limitation is treated as
a capital loss. For losses incurred in taxable years beginning after 1978, the maximum
amount that a taxpayer may claim as an ordinary loss for all losses sustained on
§1244 stock in a taxable year is $50,000, generally, or $100,000 if a joint return
Because the rules under §1244 are complicated, we encourage you to contact us
to discuss how they apply to your situation.