Reference no: EM13340621
Our clients Mr. Smith and Ms. Jones are the sole owners of JS Inc. JS Inc. is an S corporation. Mr. Smith and Ms. Jones are unrelated parties and each own half the stock of JS Inc. Four years ago their S corporation purchased stock in Highhopes Inc. at a cost of $200,000. This stock was purchased directly from Highhopes Inc. At the time Highhopes qualified as a small business corporation and its stock qualified as §1244 stock.
The Highhopes stock was sold in 2010. Highhopes had suffered several business and financial setbacks and as a result the stock was sold for only $20,000.
Our clients are currently under audit. The unresolved issue relates to this stock loss. Each client showed their share of the loss ($90,000 each) on their individual income tax returns. Both clients were married in 2010 and filed a joint tax return. It was their understanding that the entire loss could be shown as an ordinary loss and their returns were filed showing the loss as ordinary.
The Internal Revenue Service has reclassified the loss on each of their returns as a capital loss. As neither client has any capital gains the adjustment proposed by the Service is $87,000 (the original $90,000 - $3,000). The clients have asked our opinion regarding the correctness of this determination.
In my preliminary discussion with the clients, I indicated that the maximum amount which can be shown as ordinary loss under §1244 on a joint return is $100,000 per year. Also, I indicated that it was my understanding that IRC §1366(b) allows an S corporation shareholder to be deemed to have entered into the same transaction as the S corporation for purposes of determining the character of any loss.
Please look into this matter on behalf of our clients.
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