FAQ – Tax Issues

tax issues

Are you tax accountants, tax attorneys, or securities attorneys?

No, but CapGain Solutions does have highly qualified tax and legal counsel who have vetted our policies and procedures.  That said here is the standard disclaimer on advice:

IRS CIRCULAR 230 NOTICE: Please be advised that, based on current IRS rules and standards, the advice above was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer. If this message is provided in any manner to another taxpayer, he or she cannot use the advice and should seek advice based on his or her own particular circumstances from an independent tax advisor.

What are the tax rules on worthless securities?

Here is useful information from US tax code
§ 1.165-5
Worthless securities.
(a) Definition of security. As used in section 165(g) and this section, the term “security” means:
(1) A share of stock in a corporation;
(2) A right to subscribe for, or to receive, a share of stock in a corporation; or
(3) A bond, debenture, note, or certificate, or other evidence of indebtedness to pay a fixed or determinable sum of money, which has been issued with interest coupons or in registered form by a domestic or foreign corporation or by any government or political subdivision thereof.
(b) Ordinary loss. If any security which is not a capital asset becomes wholly worthless during the taxable year, the loss resulting therefrom may be deducted under section 165(a) as an ordinary loss.
(c) Capital loss. If any security which is a capital asset becomes wholly worthless at any time during the taxable year, the loss resulting therefrom may be deducted under section 165(a) but only as though it were a loss from a sale or exchange, on the last day of the taxable year, of a capital asset. See section 165(g)(1). The amount so allowed as a deduction shall be subject to the limitations upon capital losses described in paragraph (c)(3) of § 1.165-1.
(d) Loss on worthless securities of an affiliated corporation— (1) Deductible as an ordinary loss. If a taxpayer which is a domestic corporation owns any security of a domestic or foreign corporation which is affiliated with the taxpayer within the meaning of subparagraph (2) of this paragraph and such security becomes wholly worthless during the taxable year, the loss resulting therefrom may be deducted under section 165(a) as an ordinary loss in accordance with paragraph (b) of this section. The fact that the security is in fact a capital asset of the taxpayer is immaterial for this purpose, since section 165(g)(3) provides that such security shall be treated as though it were not a capital asset for the purposes of section 165(g)(1). A debt which becomes wholly worthless during the taxable year shall be as an ordinary loss in accordance with the provisions of this subparagraph, to the extent that such debt is a security within the meaning of paragraph (a)(3) of this section.
(2) Affiliated corporation defined. For purposes of this paragraph, a corporation shall be treated as affiliated with the taxpayer owning the security if—
(i) (a) In the case of a taxable year beginning on or after January 1, 1970, the taxpayer owns directly—
(1) Stock possessing at least 80 percent of the voting power of all classes of such corporation’s stock, and
(2) At least 80 percent of each class of such corporation’s nonvoting stock excluding for purposes of this subdivision (i)(a) nonvoting stock which is limited and preferred as to dividends (see section 1504(a) ), or
(b) In the case of a taxable year beginning before January 1, 1970, the taxpayer owns directly at least 95 percent of each class of the stock of such corporation;
(ii) None of the stock of such corporation was acquired by the taxpayer solely for the purpose of converting a capital loss sustained by reason of the worthlessness of any such stock into an ordinary loss under section 165(g)(3), and
(iii) More than 90 percent of the aggregate of the gross receipts of such corporation for all the taxable years during which it has been in existence has been from sources other than royalties, rents (except rents derived from rental of properties to employees of such corporation in the ordinary course of its operating business), dividends, interest (except interest received on the deferred purchase price of operating assets sold), annuities, and gains from sales or exchanges of stocks and securities. For this purpose, the term “gross receipts” means total receipts determined without any deduction for cost of goods sold, and gross receipts from sales or exchanges of stocks and securities shall be taken into account only to the extent of gains from such sales or exchanges.
(e) Bonds issued by an insolvent corporation. A bond of an insolvent corporation secured only by a mortgage from which nothing is realized for the bondholders on foreclosure shall be regarded as having become worthless not later than the year of the foreclosure sale, and no deduction in respect of the loss shall be allowed under section 165(a) in computing a bondholder’s taxable income for a subsequent year. See also paragraph (d) of § 1.165-1.
(f) Decline in market value. A taxpayer possessing a security to which this section relates shall not be allowed any deduction under section 165(a) on account of mere market fluctuation in the value of such security. See also § 1.165-4.
(g) Application to inventories. This section does not apply to any loss upon the worthlessness of any security reflected in inventories required to be taken by a dealer in securities under section 471. See § 1.471-5.
(h) Special rules for banks. For special rules applicable under this section to worthless securities of a bank, including securities issued by an affiliated bank, see § 1.582-1.
(i) Abandonment of securities— (1) In general. For purposes of section 165 and this section, a security that becomes wholly worthless includes a security described in paragraph (a) of this section that is abandoned and otherwise satisfies the requirements for a deductible loss under section 165. If the abandoned security is a capital asset and is not described in section 165(g)(3) and paragraph (d) of this section (concerning worthless securities of certain affiliated corporations), the resulting loss is treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset. See section 165(g)(1) and paragraph (c) of this section. To abandon a security, a taxpayer must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security. For purposes of this section, all the facts and circumstances determine whether the transaction is properly characterized as an abandonment or other type of transaction, such as an actual sale or exchange, contribution to capital, dividend, or gift.
(2) Effective/applicability date. This paragraph (i) applies to any abandonment of stock or other securities after March 12, 2008.
(j) Examples. The provisions of this section may be illustrated by the following examples:
Example 1.
(i) X Corporation, a domestic manufacturing corporation which makes its return on the basis of the calendar year, owns 100 percent of each class of the stock of Y Corporation; and, in addition, 19 percent of the common stock (the only class of stock) of Z Corporation, which it acquired in 1948. Y Corporation, a domestic manufacturing corporation which makes its return on the basis of the calendar year, owns 81 percent of the common stock of Z Corporation, which it acquired in 1946. It is established that the stock of Z Corporation, which has from its inception derived all of its gross receipts from manufacturing operations, became worthless during 1971.
(ii) Since the stock of Z Corporation which is owned by X Corporation is a capital asset and since X Corporation does not directly own at least 80 percent of the stock of Z Corporation, any loss sustained by X Corporation upon the worthlessness of such stock shall be deducted under section 165(g)(1) and paragraph (c) of this section as a loss from a sale or exchange on December 31, 1971, of a capital asset. The loss so sustained by X Corporation shall be considered a long-term capital loss under the provisions of section 1222(4), since the stock was held by that corporation for more than 6 months.
(iii) Since Z Corporation is considered to be affiliated with Y Corporation under the provisions of paragraph (d)(2) of this section, any loss sustained by Y Corporation upon the worthlessness of the stock of Z Corporation shall be deducted in 1971 under section 165(g)(3) and paragraph (d)(1) of this section as an ordinary loss.
Example 2.
(i) On January 1, 1971, X Corporation, a domestic manufacturing corporation which makes its return on the basis of the calendar year, owns 60 percent of each class of the stock of Y Corporation, a foreign corporation, which it acquired in 1950. Y Corporation has, from the date of its incorporation, derived all of its gross receipts from manufacturing operations. It is established that the stock of Y Corporation became worthless on June 30, 1971. On August 1, 1971, X Corporation acquires the balance of the stock of Y Corporation for the purpose of obtaining the benefit of section 165(g)(3) with respect to the loss it has sustained on the worthlessness of the stock of Y Corporation.
(ii) Since the stock of Y Corporation which is owned by X Corporation is a capital asset and since Y Corporation is not to be treated as affiliated with X Corporation under the provisions of paragraph (d)(2) of this section, notwithstanding the fact that, at the close of 1971, X Corporation owns 100 percent of each class of stock of Y Corporation, any loss sustained by X Corporation upon the worthlessness of such stock shall be deducted under the provisions of section 165(g)(1) and paragraph (c) of this section as a loss from a sale or exchange on December 31, 1971, of a capital asset.
Example 3.
(i) X Corporation, a domestic manufacturing corporation which makes its return on the basis of the calendar year, owns 80 percent of each class of the stock of Y Corporation, which from its inception has derived all of its gross receipts from manufacturing operations. As one of its capital assets, X Corporation owns $100,000 in registered bonds issued by Y Corporation payable at maturity on December 31, 1974. It is established that these bonds became worthless during 1971.
(ii) Since Y Corporation is considered to be affiliated with X Corporation under the provisions of paragraph (d)(2) of this section, any loss sustained by X Corporation upon the worthlessness of these bonds may be deducted in 1971 under section 165(g)(3) and paragraph (d)(1) of this section as an ordinary loss. The loss may not be deducted under section 166 as a bad debt. See section 166(e).
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as amended by T.D. 7224, 37 FR 25928, Dec. 6, 1972; T.D. 9386, 73 FR 13124, Mar. 12, 2008]

Is your service fee tax deductible?

Yes. Depending on your tax situation, it increases the tax basis of your investment in the asset(s), allowing for a larger loss or it is a deductible investment expense.

What is the worst case for not using CapGain Solutions

One bad scenario is you sell your private stock to your lawyer, friend, back office firm or brother-in-law.  The IRS audits the transaction a couple of years later and says the sale was not an arms length, non related party transaction. They also determine that the private stock was worthless the year before you did your transaction.  The year in which the stock because worthless in is beyond the statue of limitations for amending your return. In that case, you many lose the use of the capital loss forever! Now that is bad — a good reason to use CapGain Solutions for sure!

I don’t have capital gains this year. Should I still sell my losers now?

It is worth considering.  Selling this year will establish a definitive date of your capital losses on your losing investment. You may be able to offset $3,000 of regular income in the current tax year, and you will be able to carry your remaining capital losses forward into future years.  See our links to relevant IRS publications.

What about ordinary income? Can I offset that?

In many cases, it may be possible.  Check with your tax advisor, as CapGain Solutions does not give tax advice.

For a discussion of this question from the AAII Journal, visit http://www.aaii.com/journal/article/capital-pains-rules-for-capital-losses.touch

If you are an individual or partnership that purchased 1244 stock in an IPO, read this http://www.wisegeek.com/what-is-1244-stock.htm

and this

http://www.law.cornell.edu/uscode/text/26/1244

Can’t I just write off my investment after the company declares bankruptcy?

You might have to wait until the final, non-appealable discharge from bankruptcy, which could take years.  To realize your tax loss in the current year, sell your asset now to CapGain Solutions.

Will your tax accountants represent me at an audit?

Yes, our tax advisors will represent you, subject to you being acceptable to their standard new client procedure.  They will bill you at their standard hourly rate.

Where can I find more tax information?

Here are links to some of the relevant tax analysis, IRS publications and other resources on asset disposition:

Start the selling process today and protect your capital gains this year!

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any advice contained in these answers was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.