All incorporated companies have stock and there are the pros and cons on each type of stock. The one type of stock I would like to present is the section 1244 stock.
What is the Section 1244 Stock? How do stocks qualify as the Section 1244 Stock?
I am writing this for sole prioprietors who are or intend to incorporate in the future with business partners. Stock is stock, ownership in a corporation; however, Section 1244 Stock is a different type of stock and it is generally used for tax purposes.
To qualify as a 1244 stock (can be common or perferred), please consult your CPA and Tax Attorney when you incorporate. As a general rule to qualify for Section 1244, the investment must be lest than 1,000,000. Section 1244 is geared for Small Businesses so Publicly Held Stocks do not qualify (not to my knowledge they don't).
e.g ABCHost has been operating for 3 years and it has grew substantially. The sole proprietor, Ralf (fictious), presents a business plan to few friends to bring his business to the next level. Under the agreement, each party (Ralf + 3 friends) invests $80,000 in the company and elects the stock as Section 1244 Stock. 2 Years went by and the company went down hill and each of the 25% share are now worth $10,000 and Ralf decides to sell the business the CBAHost for $40,000 (transfer of stock, due to complex calculations, i'm just assume they bought all the stock without considering other factors because it is irrelevant with this example).
What Happens Next?
Each partner/officer has realized $70,000 net loss.
I am just going to talk about Ralf.
Please consider the following senario:
Ralf is a healthy person and works on the side generating 100k in income from a day job, let's say he is an manager of some corp. Asuming Ralf does not elect to itemize and he does not own realestate property or have another other businesses (he is also single and lives alone without dependents).
His Taxible Income w/o withhold would look like this:
Salary - 100,000
Taxible Inc 92150 @ 28% bracket
If his CPA realizes the Section 1244 losses of 70,000. It would look like this:
Salary - 100,000
ordinary loss (50,000)
Taxible Inc 42150 @25% bracket
The Idea of Section 1244 is to allow the first $50,000 of losses as an ordinary loss and realize the rest as Long Term Capital Losses (of that you are allowed to deduct the remain losses @ $3000 per year over a period of 5 years). If the investment is treated as a normal investment, the $50,000 will not be an ordinary loss but will realized in chunks of $3000 as LTCL. I hope I didn't confuse everyone