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Using a small business C-Corp tax loss

• I bought a franchise in 2001 and created an Oregon C-Corp of which I am the only officer and shareholder. I capitalized the venture with $25,000 of capital stock (100 shares, no par value) and, over the next two years, $250,000 in shareholder loans. I sold all the assets of the corporation back to the franchisor in 2002 for $76,000. I now have a C-Corp with no assets, $250,000 in shareholder loans, and -$250,000 in equity ($25,000 capital stock, -$145,000 retained earnings, -$130,000 loss on the sale of assets). What are the options for utilizing this tax loss? Can I take deductions against ordinary income? Against other investment capital gains? I have no other small business opportunities on the horizon. Can I safely dissolve the corporation? I'm looking for some background and possible references before going to a professional. Do I need an accountant, an attorney, a tax attorney? Thank you for your assistance with this request.

• Answer:

  Hello and thank you for your question. You should be able to use your stock loss as a deduction against ordinary income, by qualifying the stock investment as Section 1244 stock. You would also be able to use your loan loss as a deduction against ordinary income, but only if you can qualifying the loan as a business loan. If the loan was a nonbusiness loan (see below for the distinction) then the loss on the loan is a capital loss. You'll need a good accountant to help you properly substantiate business loan treatment, and to figure out the amount of these losses. For the stock investment, up to $50,000 of the loss [$100,000 if filing jointly] should be able to qualify for ordinary loss treatment, meaning it can be deducted against ordinary (salary, etc.) income. For the loan, if it is a "business bad debt" you can likewise deduct the loss against ordinary income, while if it is a "nonbusiness bad debt" your loss is a capital loss, limited to sheltering $3,000 per year of ordinary income and otherwise only as an offset to long term capital gains. Stock: "Section 1244 (Small Business) Stock Individuals report ordinary losses from the sale or exchange (including worthlessness) of section 1244 (small business) stock on line 10. To qualify as section 1244 stock, all ... of the following requirements must be met. You acquired the stock after June 30, 1958, upon original issuance of the shares from a domestic corporation (or the stock was acquired by a partnership in which you were a partner continuously from the date the stock was issued until the time of the loss). .... [The] total amount of money and other property received by the corporation for its stock as a contribution to capital and paid-in surplus generally may not exceed $1 million. The stock was issued for money or other property (excluding stock or securities). The corporation, for its 5 most recent tax years ending before the date of the loss, derived more than 50% of its gross receipts from sources other than royalties, rents, dividends, interest, annuities, and gains from sales and exchanges of stocks or securities. (If the corporation was in existence for at least 1 tax year but fewer than 5 tax years ending before the date of the loss, the 50% test applies for the tax years ending before that date. If the corporation was not in existence for at least 1 tax year ending before the date of the loss, the 50% test applies for the entire period ending before that date.) The 50% test does not apply if the corporation's deductions (other than the net operating loss and dividends-received deductions) exceeded its gross income during the applicable period. But this exception to the 50% test applies only if the corporation was largely an operating company within the 5 most recent tax years ending before the date of the loss (or, if less, the entire period the corporation was in existence). The maximum amount that may be treated as an ordinary loss is $50,000 ($100,000 if married filing jointly)." http://www.irs.gov/instructions/i4797/ar01.html Shareholder Loan: "If a shareholder lends money to a corporation in his or her capacity as an investor, any resulting bad debt generally is classified as nonbusiness. However, if the loan is made in some capacity that qualifies as a trade or business, the shareholder-creditor can incur a business bad debt. Employee status is a trade or business, and a loss on a loan made to protect the shareholder's position as an employee qualifies for business bad debt treatment." http://www.cwu.edu/~vautiera/HOFFMAN%20CPET%202005%20SM/Corporations%20SM%20Ch03.doc "An employee who loans money to his employer with the motive of retaining his job has a case for claiming a business bad debt, but what if the employee is also an investor in the company? The Supreme Court ruled in Generes that the test must be whether the dominant motive was business. In that case, a taxpayer who owned 44% of a construction company and was paid $12,000 per year for serving as president on a part-time basis, loaned the company a considerable amount of money. He sought to deduct the losses on such loans as business because a significant motive in loaning the money was business. The Court, in deciding for the government, said that the test must be that of a dominant business motive because among other reasons-- * The code considers the distinction between business and nonbusiness to be important. * Without the dominant motive test, employee-shareholders would always have at least a significant business motive. The thrust of Generes has been to make business bad debt treatment more difficult to attain." http://www.nysscpa.org/cpajournal/old/14152798.htm As noted above, you'll need a good accountant to help you get this right. Probably you won't need an attorney unless you're called on to defend the business bad debt position in the event of an audit. Search terms used: 1244 site:irs.gov "shareholder loan" "bad debt" stockholder "bad debt" business nonbusiness Thanks again for letting us help. Google Answers Researcher Richard-ga