I have been researching to determine if S Corporation stock qualifies for ordinary loss treatment under IRC Section 1244. In reading the definition of "small business corporation" in this section, it seems to be unclear if it applies only to C Corp. stock. Contrast this with the special capital gain treatment under Section 1202 which specifically states that only C Corp. stock qualifies as "small business stock". Would appreciate any thoughts or advice on this.
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I don’t see anything in Section 1244 that says stock in an S corporation does not qualify.
However, that issue may be a moot point.
Section 1244(d)(1)(B) says:
What does that mean?In computing the amount of the loss on stock for purposes of this section, any increase in the basis of such stock (through contributions to the capital of the corporation, or otherwise) shall be treated as allocable to stock which is not section 1244 stock.
Well only the original contribution of cash in exchange for stock qualifies for 1244 treatment. An S corporation basis in stock increases due to a number of reasons, such as for income passed through to shareholders on the K-1. That increase in basis does not count as section 1244 stock.
Another issue is that an S corporation already passes through ordinary losses to the shareholder on the K-1, thus eliminating the need for Section 1244 treatment.
Example: You give $100 to the S corporation in exchange for stock. The S corporation earns $10,000 in year one, and no distributions are made. Stock basis = $10,100. Section 1244 stock = $100. In year two, the corporation spends $10,100 and does not earn a dime. It then liquidates. S corporation losses on K-1 = $10,100. All allowed due to basis. Basis in stock after the pass through loss allowed equals zero. S corporation dissolves. Section 1244 loss = zero because none of the $100 stock basis was left at the time of liquidation.
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