Ushio v. Commissioner: Taxpayers Erroneously Claim Section 1244 Stock Deduction

In the recent case of Ushio v. Commissioner, a couple attempted to claim a $50,000 ordinary loss using Section 1244 of the tax code. However, since the deduction claim did not meet multiple requirements, the US tax court determined it to be invalid.

Phoenix Tax Attorney Explaining The Case Of Taxpayers That Erroneously Claimed Section 1244 Stock Deduction

What is Section 1244?

Enacted by Congress in 1984, Section 1244 of the Internal Revenue code is a deduction that was intended to encourage investment into small business corporations by reducing the overall risk of investment. With this deduction, taxpayers can claim losses on certain investments as an ordinary loss instead of as a capital loss. The taxpayer can claim a loss of up to $50,000, or up to $100,000 on a jointly filed return.

In order to qualify for a Section 1244 deduction, the corporation and the stock must meet several requirements. These requirements include:

  • The stock must be issued by a corporation in the U.S.
  • The corporation’s equity must not exceed $1,000,000 at the time that the stock is issued.
  • For the five taxable years before the loss is claimed, the corporation must have received at least 50% of its gross receipts from business operations, not passive income such as royalties, rents, interests, etc.
  • Only the taxpayer who purchased the stock directly from the company qualifies for the deduction.
  • Ushio’s Attempt to Claim Section 1244

    A couple invested $50,000 by purchasing 50 shares of stock in PCHG, a South Carolina corporation that stated it was working to obtain rights to a process related to alternative energy production. Unfortunately, this corporation did not have any gross receipts indicating its financial records, closed its doors in 2012, and was dissolved by the state of South Carolina in 2013.

    PCHG signed an undated agreement with two other companies and D4 Energy Group, Inc. in an attempt to obtain the rights to the D4 process, which it hoped to use in its own alternative energy projects.

    When Mr. and Mrs. Ushio claimed the stock investment on their taxes citing Section 1244, the IRS audited their return and took them to tax court. The IRS claimed that the taxpayers had failed to demonstrate that the stock qualified under Section 1244. The tax court agreed with the assessment of the IRS, leaving Mr. and Mrs. Ushio without the deduction and with a hefty financial loss.

    Key Issues in Ushio v. Commissioner

    One of the primary issues in this case was that PCHG as a corporation had no operations. In addition, the taxpayers could not prove that the corporation had not received more than $1 million in stock as stated in the tax code. Lastly, PCHG as a corporation failed to meet the stated requirements of Section 1244, which stated that the corporation could not derive more than 50% of its aggregate gross receipts from sources other than royalties, rents, dividends, interests, annuities, and sales or exchanges of stocks or securities. In fact, the taxpayers could not even verify where PCHG had received any of its income because it did not have any gross receipts at all.

    Mr. and Mrs. Ushio presented a document to the court that they stated proved PCHG’s stock had not exceeded $1 million. However, the document was undated and did not provide enough detail to support their assertion. Additionally, there was no documentation available to prove that PCHG was an operational company. The court ruled in favor of the IRS.

    The case of Ushio v. Commissioner was an open-and-close case. To prevent this tax loss and the ensuing tax court case, it would have been beneficial for the taxpayers to have consulted a qualified tax lawyer before claiming Section 1244.

    Contact an Experienced Tax Law Firm in Phoenix

    The experienced and reputable tax attorneys at Silver Law PLC are ready to help you with your tax representation needs. Whether you are facing the IRS, have litigation problems with foreign tax reporting, or are seeking innocent spouse relief, the attorneys at Silver Law PLC are the experts you need on your side. Contact our offices today to get started with the protection of your rights.


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