Southwestern Law Journal
Most investors who contemplate a new business venture concentrate on the positive financial aspects of the business. Few investors realize that a thorough tax plan for a prospective business must also account for the contingency of failure. Since the failure of a business venture will, in some way, result in a taxable event, the conscientious corporate planner must devise a strategy that will utilize the losses incurred in order to achieve the most advantageous tax result. Internal Revenue Code section 1244 is not new, not particularly complex, and not fraught with misfortune for taxpayers failing to meet its provisions. This section is, however, relatively unknown to many attorneys, even though not qualifying a new corporation's stock under section 1244 is tantamount to malpractice.
In most cases, when a stockholder's investment in a corporation becomes worthless, the investor's loss will constitute a capital loss. In contrast, a partner or individual proprietor in a losing venture usually is entitled to deduct his loss as an ordinary loss. In 1958, Congress alleviated this disparity between corporate and noncorporate business forms by enacting two compensatory changes to the Code. The first change, subchapter S, exempts certain corporations from the corporate income tax and passes the corporation's income and losses directly to the corporation's shareholders. The second change, section 1244, allows certain stockholders to deduct realized losses on corporate stock as ordinary losses. This Article discusses section 1244, its requirements, effects, and problems.
Henry F. Johnson & Mark W. Cochran, Looking a Gift-Horse in the Mouth: Some Observations and Suggestions for Improving Internal Revenue Code Section 1244, 39 Sw. L. J. 975 (1986).