§ 1.1244(c)-2 Small business corporation defined.
(a) In general. A corporation is treated as a small business corporation if it is a domestic corporation that satisfies the requirements described in paragraph (b) or (c) of this section. The requirements of paragraph (b) of this section apply if a loss is sustained on post-November 1978 stock. The requirements of paragraph (c) of this section apply if a loss is sustained on pre-November 1978 stock. If losses are sustained on both pre-November 1978 stock and post-November 1978 stock in the same taxable year, the requirements of paragraph (b) of this section are applied to the corporation at the time of the issuance of the stock (as required by paragraph (b) in the case of a loss on post-November 1978 stock) in order to determine whether the loss on post-November 1978 stock qualifies as a section 1244 loss, and the requirements of paragraph (c) of this section are applied to the corporation at the time of the adoption of the plan (as required by paragraph (c) in the case of a loss on pre-November 1978 stock) in order to determine whether the loss on pre-November 1978 stock qualifies as a section 1244 loss. For definition of domestic corporation, see section 7701 (a)(4) and the regulations under that section.
(b) Post-November 1978 stock—(1) Amount received by corporation for stock. Capital receipts of a small business corporation may not exceed $1,000,000. For purposes of this paragraph the term capital receipts means the aggregate dollar amount received by the corporation for its stock, as a contribution to capital, and as paid-in surplus. If the $1,000,000 limitation is exceeded, the rules of subparagraph (2) of this paragraph (b) apply. In making these determinations, (i) property is taken into account at its adjusted basis to the corporation (for determining gain) as of the date received by the corporation, and (ii) this aggregate amount is reduced by the amount of any liability to which the property was subject and by the amount of any liability assumed by the corporation at the time the property was received. Capital receipts are not reduced by distributions to shareholders, even though the distributions may be capital distributions.
(2) Requirement of designation in event $1,000,000 limitation exceeded.
(i) If capital receipts exceed $1,000,000, the corporation shall designate as section 1244 stock certain shares of post-November 1978 common stock issued for money or other property in the transitional year. For purposes of this paragraph, the term transitional year means the first taxable year in which capital receipts exceed $1,000,000 and in which the corporation issues stock. This designation shall be made in accordance with the rules of subdivision (iii) of this paragraph (b)(2). The amount received for designated stock shall not exceed $1,000,000 less amounts received—
(A) In exchange for stock in years prior to the transitional year;
(B) As contributions to capital in years prior to the transitional year; and
(C) As paid-in surplus in years prior to the transitional year.
(ii) Post-November 1978 common stock issued for money or other property before the transitional year qualifies as section 1244 stock without affirmative designation by the corporation. Post-November 1978 common stock issued after the transitional year does not qualify as section 1244 stock.
(iii) The corporation shall make the designation required by subdivision (i) of this paragraph (b)(2) not later than the 15th day of the third month following the close of the transitional year. However, in the case of post-November 1978 common stock issued on or before June 2, 1981 the corporation shall make the required designation by August 3, 1981 or by the 15th day of the 3rd month following the close of the transitional year, whichever is later. The designation shall be made by entering the numbers of the qualifying share certificates on the corporation's records. If the shares do not bear serial numbers or other identifying numbers or letters, or are not represented by share certificates, the corporation shall make an alternative designation in writing at the time of issuance, or, in the case of post-November 1978 common stock issued on or before June 2, 1981 by August 3, 1981. This alternative designation may be made in any manner sufficient to identify the shares qualifying for section 1244 treatment. If the corporation fails to make a designation by share certificate number or an alternative written designation as described, the rules of subparagraph (3) of this paragraph (b) apply.
(3) Allocation of section 1244 benefit in event corporation fails to designate qualifying shares. If a corporation issues post-November 1978 stock in the transitional year and fails to designate certain shares of post-November 1978 common stock as section 1244 stock in accordance with the rules of subparagraph (2) of this paragraph (b), the following rules apply:
(i) Section 1244 treatment is extended to losses sustained on post-November 1978 common stock issued for money or other property in taxable years before the transitional year and is withheld from losses sustained on post-November 1978 stock issued in taxable years after the transitional year.
(ii) Post-1958 capital received before the transitional year is subtracted from $1,000,000.
(iii) Subject to the annual limitation described in § 1.1244(b)-1, an ordinary loss on post-November 1978 common stock issued for money or other property in the transitional year is allowed in an amount which bears the same ratio to the total loss sustained by the individual as:
(A) The amount described in § 1.1244(c)-2(b) (3) (ii) bears to
(B) The total amount of money and other property received by the corporation in exchange for stock, as a contribution to capital, and as paid-in surplus in the transitional year.
(4) Examples. The provisions of this paragraph (b) may be illustrated by the following examples:
Example 1.
On December 1, 1978,
Corporation W, a newly-formed
corporation,
issues 10,000 shares of common stock at $125 a share for an
amount (determined under subparagraph (1) of this paragraph (b)) of money and
other property totaling $1,250,000.
The board of directors specifies that 8,000 shares are section 1244
stock and records
the certificate numbers of
the qualifying shares in its minutes. Because
Corporation W issued post-November 1978 common stock in
exchange for money and
other property exceeding $1,000,000, but has designated
shares of stock as section 1244
stock and
the designated shares were issued in
exchange for money and
other property not exceeding $1,000,000 (8,000 shares × $125 price per share = $1,000,000),
the 8,000 designated shares qualify as section 1244
stock.
Example 2.
Corporation X comes into existence on June 1, 1979. On June 10, 1979,
Corporation X
issues 2,500 shares of common stock at $250 per share to
shareholder A and 2,500 shares of common stock at $250 per share to
shareholder B. By written agreement dated September 1, 1981,
shareholder A and
shareholder B determine that 1,500 of
shareholder A's shares and all of
shareholder B's shares will be treated as section 1244
stock. Although
shareholder A's 1,500 shares and
shareholder B's 2,500 shares were issued for money and
other property not exceeding $1,000,000 (4,000 shares × $250 price per share = $1,000,000, these 4,000 shares do not qualify as section 1244
stock under
the rules of subparagraph (2) of this paragraph (b) for three reasons: The agreement of September 1, 1979, (i) did not identify which 1,500 of
shareholder A's 2,500 shares were intended to qualify for section 1244
treatment, (ii) was made by
the shareholders and not by
Corporation X, and (iii) was made later than
the 15th
day of
the third month
following the close of
the transitional
year. However, certain of
the shares issued by
Corporation X may qualify as section 1244
stock under
the rules of subparagraph (3) of this paragraph (b). See
example (4).
Example 3.
On December 1, 1980,
Corporation Y
issues common stock to
shareholder A in
exchange for $500,000 in
cash. On August 1, 1981,
Corporation Y
issues common stock to
shareholder B in
exchange for
property having an
adjusted basis to
Corporation Y of $500,000. On December 1, 1981, B
transfers a tract of
land having a
basis in B's hands of $250,000 to
Corporation Y as a contribution to capital. Under section 362(a)(2) of
the Code,
Corporation Y takes a
basis of $250,000 in
the tract of
land.
Corporation Y is a
calendar year corporation. On February 15, 1982, it designates all of
shareholder B's
stock as section 1244
stock by entering
the numbers of
the qualifying certificates on
the corporation's records.
The designation made by
Corporation Y is effective because it identifies which shares of its
stock qualify for section 1244
treatment, was made in writing before
the 15th
day of
the 3rd month
following the close of
the transitional
year (1981), and because
the amount received for designated
stock does not exceed $1,000,000, less amounts received (i) in
exchange for
stock in
years prior to
the transitional
year; (ii) as contributions to capital in
years prior to
the transitional
year; and (iii) as paid-in surplus in
years prior to
the transitional
year. Nevertheless, in
the event of B's
sale of his
stock at a
loss,
the increase in basis attributable to his December, 1981, contribution to capital will be treated as allocable to
stock that is not section 1244
stock under
§ 1.1244(d)-2.
Example 4.
Corporation Z, a newly-formed
corporation,
issues 10,000 shares of common stock at $200 per share on July 1, 1979. In
exchange for its stock Corporation Z receives
property (
other than
stock or securities) having a basis to
the corporation of $400,000, and $1,600,000 in
cash, for a total of $2,000,000.
Corporation Z fails to designate any of
the issued shares as section 1244
stock.
Shareholder C purchases 2,500 shares of
the 10,000 shares of
Corporation Z
stock for $500,000 on July 1, 1979. Subsequently,
shareholder C sells
the 2,500 shares for $400,000.
Shareholder C may treat $50,000 of
the $100,000
loss as an ordinary
loss under section 1244.
The amount of that
loss is computed under
the rule of subparagraph (3) of this paragraph (b) as follows:
| X [C's section 1244 loss]
|
=
|
$1,000,000 [$1,000,000 −0 = $1,000,000]
|
| $100,000 [C's total loss]
|
$2,000,000 [total amount received by Corporation Z]
|
|
|
|
| X = $50,000 |
The remaining $50,000 is not treated as an ordinary loss under section 1244.
Example 5.
(i) Corporation V, a newly-formed corporation, issues common stock to shareholder A and shareholder B on June 15, 1980, in exchange for $800,000 in cash ($400,000 from A and $400,000 from B). On September 15, 1981, the corporation issues common stock to shareholder C in exchange for $600,000 in cash. On January 1, 1982, common stock is issued to shareholder D in exchange for $100,000 in cash. Corporation V fails to designate any of the issued shares as section 1244 stock. A, B, C, and D subsequently sell their Corporation Y stock at a loss.
(ii) Subject to the annual limitation discussed in § 1.1244(b)-1, A and B may treat their entire loss as an ordinary loss under section 1244. D may not treat any part of his loss as an ordinary loss under section 1244. Subject to the annual limitation, one-third of the loss sustained by shareholder C is treated as an ordinary loss under section 1244. These results are calculated under the rules of subparagraph (3) of this paragraph (b) as follows: First, section 1244 treatment is extended to post-November 1978 stock issued to A and B in 1980, a taxable year before the transitional year (1981); section 1244 treatment is withheld from the stock issued to D in 1982, a taxable year after the transitional year. Second $800,000 the amount of post-1958 capital received in taxable years before the transitional year, is subtracted from $1,000,000 to leave $200,000. Third, subject to the annual limitation, an ordinary loss is allowed to C in an amount which bears the same ratio to his total loss as the amount calculated in the preceding sentence ($200,000) bears to the total amount received by the corporation in the transitional year in exchange for stock, as a contribution to capital, or as paid-in surplus ($600,000).
Example 6.
Corporation V comes into existence on July 1, 1982. On that date it
issues 10 shares of voting common stock to
shareholder A in
exchange for $500,000 and 5 shares of voting common stock to
shareholder B in
exchange for $250,000, designating
the shares issued to both A and B as section 1244
stock. On September 15, 1982,
Corporation V receives a contribution to capital from
shareholders A and B having a
basis in their hands of $225,000. On February 1, 1983,
Corporation V
issues one share of stock to
shareholder C in
exchange for $50,000.
Corporation V may designate one-half of
the share issued to
shareholder C as section 1244
stock under
§ 1.1244(c)-2 (b)(2). In 1982
the corporation received $750,000 for
stock ($500,000 from A and $250,000 from B) and $225,000 as a capital
contribution, totaling $975,000 in capital
receipts.
The receipt of $50,000 from
shareholder C in
exchange for
stock in 1983 causes capital receipts to exceed $1,000,000 and 1983 thus becomes
Corporation V's transitional
year.
Corporation V may receive only $25,000 for designated
stock in 1983 under
the rule set forth in
§ 1.1244 (c)-2 (b)(2)(i), which
states that
the amount received for designated
stock shall not exceed $1,000,000, less amounts received (i) in
exchange for
stock in
years prior to
the transitional
year ($750,000 from A and B), (ii) as contributions to capital in
years prior to
the transitional
year ($225,000), and (iii) as paid-in surplus in
years prior to
the transitional
year ($0). Thus, one-half of C's share (representing
the receipt of $25,000) may be designated as section 1244
stock by
Corporation V. In
the event of
the sale of A's
stock or B's
stock at a
loss,
the increase in basis attributable to their contribution to capital will be treated as allocable to
stock that is not section 1244
stock under
§ 1.1244(d)-2.
(c) Pre-November 1978 stock—(1) Amount received by corporation for stock. At the time of the adoption of the plan, the sum of the aggregate dollar amount to be paid for pre-November 1978 stock that may be offered under the plan plus the aggregate amount of money and other property that has been received by the corporation after June 30, 1958, and on or before November 6, 1978, for its stock, as a contribution to capital by its shareholders, and as paid-in surplus must not exceed $500,000. In making these determinations (i) property is taken into account at its adjusted basis to the corporation (for determining gain) as of the date received by the corporation, and (ii) this aggregate amount is reduced by the amount of any liability to which the property was subject and by the amount of any liability assumed by the corporation at the time the property was received. For purposes of the $500,000 test, the total amount of money and other property received for stock, as a contribution to capital, and as paid-in surplus is not reduced by distributions to shareholders, even though the distributions may be capital distributions. Thus, once the total amount of money and other property received after June 30, 1958, reaches $500,000, the corporation is precluded from subsequently issuing pre-November 1978 stock. For a different rule that applies to post-November 1978 stock see § 1.1244(c)-2(b).
(2) Equity capital. The sum of the aggregate dollar amount to be paid for pre-November 1978 stock that may be offered under the plan plus the equity capital of the corporation (determined on the date of the adoption of the plan) may not exceed $1,000,000. For this purpose, equity capital is the sum of the corporation's money and other property (in an amount equal to its adjusted basis for determining gain) less the amount of the corporation's indebtedness to persons other than its shareholders.
(3) Examples. The provisions of this paragraph (c) may be illustrated by the following examples:
Example 1.
Corporation W comes into existence on December 1, 1958. On that date
the corporation may adopt a plan to
issue common stock for an
amount (determined under subparagraph (1) of this paragraph (c)) not in excess of $500,000 during a period ending not later than November 30, 1960. Such
corporation will qualify as a
small business corporation as of
the date that
the plan is adopted. However, if
the corporation adopts a plan to
issue stock for an
amount in excess of $500,000 it is not a
small business corporation at
the time
the plan is adopted and no
stock issued under
the plan may qualify as section 1244
stock. If
the cost of organizing
corporation W amounted to $1,000 and constituted paid-in surplus or a contribution to capital, such
amount must be taken into
account in determining
the amount that may be received under
the plan, with
the result that only $499,000 may be so received.
Example 2.
On December 1, 1958,
Corporation X, a newly formed
corporation, adopts a plan to
issue common stock for an
amount (determined under subparagraph (1) of this paragraph (c)) not in excess of $500,000 during a period ending not later than November 30, 1960. By January 1, 1960,
the corporation has, pursuant to
the plan, issued at par,
stock having an aggregate par
value of $400,000, $200,000 of which was issued for $200,000
cash, and $200,000 of which was issued for
property (
other than
stock or securities) having a basis to
the corporation of $100,000 and a
fair market value of $200,000.
The corporation may, prior to November 30, 1960,
issue stock for an
amount not in excess of $200,000
cash or
property having a basis to it not in excess of $200,000.
Stock issued for any
payment which, alone or together with any
payments received after January 1, 1960, exceeds such $200,000
amount would not qualify as section 1244
stock because it would not be issued pursuant to
the plan.
Example 3.
Assume that on December 1, 1958,
Corporation Y, a newly formed
corporation, adopts a plan to
issue common stock for an
amount (determined under subparagraph (1) of this paragraph (c)) not in excess of $500,000 during a period ending not later than November 30, 1960. By January 1960
the corporation has received $400,000
cash for
stock issued pursuant to
the plan, but due to
business successes
the equity capital of
the corporation exceeds $1,000,000. Since
the equity capital test is made as of
the date that
the plan is adopted,
the corporation may still, prior to November 30, 1960,
issue section 1244
stock pursuant to
the plan until
the full
amount specified in
the plan has been received.
Example 4.
Subsequent to June 30, 1958, Corporation Z receives a total of $600,000 cash on the issuance of its stock. In 1960 Corporation Z redeems shares of its stock for the total amount of $300,000 and the redemptions reduce Corporation Z's capital to substantially less than $500,000. Notwithstanding the redemptions, pre-November 1978 stock subsequently issued by Corporation Z will not qualify as section 1244 stock because the $500,000 limitation has been previously exceeded.
