1976, June, Pg. 792. Tax Tips.

5 Colo.Law. 792

Colorado Lawyer

1976.

1976, June, Pg. 792.

Tax Tips

792Vol. 5, No. 6, Pg. 792Tax TipsSection 1244 of the Internal Revenue Code must be seriously reviewed by any attorney who is advising a client on business planning.(fn1) It operates very favorably from a tax viewpoint by transforming a capital loss into an ordinary loss deduction while retaining the character of any capital gains.(fn2) A Sub-chapter S corporation may use § 1244 so that operating losses and losses on disposition of stock are both ordinary income deductions. Finally, since it involves use of the corporate form, § 1244 affords the protection of limited liability. These results remove some of the major advantages of using the unincorporated form for the uncertain business venture.(fn3)

If the § 1244 plan fails for any reason, the only adverse consequence for the taxpayer is that the loss on disposition of § 1244 stock is a capital loss, as would be the case for any shareholder in a regular corporation. Thus, once the decision to incorporate is made, a § 1244 plan should always be adopted. If the rules covering § 1244 become too restrictive, the plan can always be abandoned.

General Outline of § 1244Section 1244 of the Treasury Regulations impose a number of requirements on both the corporation and shareholders. Basically, any domestic corporation can adopt a written plan to offer common stock under § 1244. Although there can be only one § 1244 plan and only one stock offering operative at one time, when a plan or stock offering terminates or is withdrawn and no further offers are outstanding, a new plan to issue § 1244 stock may be adopted. The stock may be issued only for money or other property,(fn4) not including services, stock or securities.(fn5)

An individual(fn6) who is the original issuee, or who is a partner of a partnership when it is the original issuee,(fn7) of § 1244 stock is entitled to an annual ordinary loss deduction from gross income(fn8) of up to $25,000 ($50,000 when he files a joint return(fn9)) if the § 1244 stock becomes worthless or is sold, exchanged(fn10) or redeemed (whether or not in liquidation) at a loss.(fn11) On the other hand, any gain realized on the disposition of § 1244 stock is taxed the same as gain on the disposition of stock of a regular corporation, which usually results in favored capital gains treatment.

The § 1244 PlanThe plan must be in writing. It must be one to offer stock, and not a mere general authorization in a corporate charter that § 1244 stock be issued.(fn12) The plan should always specifically refer to § 1244, since the courts (although not necessarily the Internal Revenue Service) have tended to be more lenient concerning other shortcomings in a plan when an intent to use § 1244 is plainly evident.

The plan must recite the period during which § 1244 stock may be issued, ending not later than two years after the date the plan is adopted. Actual dates should be specified. It is also advisable to state that the plan will terminate upon any subsequent offering of stock, since stock issued under the plan after such other offering will not qualify as § 1244 stock.

The stock offered must be only common stock, either voting or nonvoting, and the plan must specify, in terms of dollars, the maximum amount to be received by the corporation in consideration for the § 1244 stock being issued. The offering of any other stock during the term of the plan should be expressly prohibited. The plan will therefore state the maximum number of shares (e.g., 1,000), the cost per share (e.g., $50), and the total maximum consideration (e.g., $50,000) under the offering.

Requirements When the Plan Is Adopted or Stock IssuedThe corporation must be a "small business corporation" as defined in § 1244(c)(2) of the Internal Revenue Code only at the time the plan is adopted. The benefits of § 1244 are not lost if the corporation thereafter could no longer qualify as a small business corporation.(fn13) Only capital requirements are involved. Unlike the Subchapter S provisions...