Do You Have Worthless Stock Investments?
By Mark Rousseau, JD, CPA, Tax Director
Many of us, which includes myself, have bought stock in a
company that later failed. While you may want to kick
yourself for it, it's important to at least get some benefit
from it and claim the capital loss deduction that the IRS
code allows you to take. The difficult part about it is
determining when to claim the worthless stock deduction
on your tax return.
You can go about in one or two ways.
The first way is to trigger the loss while the shares are
still being traded. Your write off will be limited to any
capital gains that you have for the year plus an additional
$3,000 (or $1,500 if you use married filing separate
status).
For example, if your WYZ stock will be sold at a loss of
$14,000 and you have a gain from your ABC stock of
$10,000, your net deduction will be $3000. The additional
$1,000 loss will be carried over until next year where your
will offset it with any capital gains for that year or you will
take a $1,000 capital loss deduction on your tax return.
The second way is to wait and take the deduction when
your shares have become wholly worthless. (Under the
Tax Code, you get no deduction for partial worthlessness.)
Once again, your write-off is limited to the amount of any
capital gains for the year, plus $3,000 (or $1,500 if you use
married filing separate status). Here is where it gets tricky.
In order to take the deduction, you must correctly identify
the year when the shares become totally worthless and
then claim your write-off in that year and that year only.
This may seem to be a no brainer but the IRS doesn't
consider your shares to be wholly worthless until it's clear
they have no liquidation value and there's no hope they
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Waiting in the IRS.
From my own experience, I had made a
claim several years ago for worthless
stock. I waited for my refund and waited
until I had to call the IRS about it. Once I
got on the phone with them, the person I
spoke with said that I wasn't getting my
refund because I had filed my amended
return after the normal three year
statutory period for filing an amended
return.
I then had to explain to the IRS that there
was that special seven year statute of
limitation in the Code that allowed me to
file the amended returns for a worthless
stock deduction within a seven year
period. A few weeks later, I received the
check in the mail for the amount of the
refund – but it was made payable to
somebody I didn't even know! I then
took the check and my story to the IRS in
Hartford and spoke to someone who
helped expedite the matter.
As you can see, there are potential
problems with claiming worthless stock
losses. The best course of action is to sell
distressed shares before they are
delisted, trigger your capital loss, and
move on. If you do hold onto them, and
they become worthless, file your claim as
soon as soon as possible.
© Copyright 2014. All rights reserved. Mahoney Sabol & Company, LLP. January 2014.
Mahoney Sabol & Company, LLP • 95 Glastonbury Blvd. • Suite 201 Glastonbury, CT 06033 • 860.541.2000
will regain any value in the future. I am sure you are saying to yourself, "How do I know that?" The area
is confusing and there is really no clear cut answer to it.
For example, the IRS has stated that bankruptcy proceedings don't necessarily establish complete
worthlessness for a company's stock. (IRS Revenue Ruling 77-17) Why? Because shareholders are not
always totally wiped out. There is some hope that the shares could become valuable again. Some court
decisions have taken more taxpayer-friendly view of this issue, but they don't establish any firm
guidelines.
Sometimes shares of delisted bankrupt companies may continue to trade on the over-the-counter
market (via a system called the "Pink Sheets") even after it is clear that shareholders will get nothing in
the bankruptcy proceedings and the shares have been legally cancelled. Cancelled shares of a delisted
bankrupt company may be trading for a few cents each (or a fraction of a cent) on the Pink Sheets
market and still not qualify as worthless by some IRS auditors. Some auditors might even disallow losses
until all trading in the shares has ceased.
The simplest solution is to sell any shares you believe will soon be worthless while they are still be
traded. Taking this step has two big advantages:
 First, you'll net at least some cash and if you procrastinate, you may wind up with nothing.
 Second, selling the shares will trigger a tax loss. If you hang on, it could be a long wait before the stock
becomes completely worthless in the eyes of the IRS and you qualify for a tax write-off.
If you decide to hold onto the shares until it becomes abundantly clear that they are indeed totally
worthless, the Tax Code requires you to claim your capital loss in the year when such total
worthlessness occurs. For the reasons explained earlier, however, it's not always clear exactly which
year that is.
When a taxpayer claims a worthless stock deduction the tax law grants a taxpayer a seven-year statute
of limitations period (Source: Internal Revenue Code Section 6511(d)(1)) -- instead of the normal three
years -- to claim a worthless stock loss. You probably have already have surmised why that would be,
but even the Congress recognizes that determining the proper year to claim a worthless stock loss can
be problematic. So the special seven year statute of limitations period helps to provide some cushion in
when to claim the worthless stock deduction. If you hold onto the shares, and they become worthless,
make sure you claim the deduction sooner rather than later before the seven-year statutory period runs
out.
As you can see, there are potential problems with claiming worthless stock losses. The best course of
action is to sell distressed shares before they are delisted, trigger your capital loss, and move on. If you
do hold onto them, and they become worthless, file your claim as soon as soon as possible.
You can now boast about your knowledge and tell all the people at your next cocktail party about the
seven-year statute of limitation period for worthless stock deductions of which many people are not
aware.
Good luck on your next investment, and contact your tax advisor if you have questions or need more
information.
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© Copyright 2014. All rights reserved. Mahoney Sabol & Company, LLP. February 2014.
Mahoney Sabol & Company, LLP • 95 Glastonbury Blvd. • Suite 201 Glastonbury, CT 06033 • 860.541.2000
About the Author
Mark Rousseau, CPA, JD, as new Tax Director for Mahoney Sabol & Company, LLP. He provides tax
planning and compliance services to clients of the firm and collaborates with the tax department to
address complex tax needs, identifies federal, state, international, and other tax issues, and coordinates
the delivery of these services.
His areas of expertise include tax planning and compliance involving Federal consolidated, multistate
corporation, S Corp, partnership, LLC, individual, estate, gift, fiduciary, and property tax returns. In
addition, areas in which he has specialized knowledge include ASC740 and ASC740-10, Foreign Reporting
and Voluntary Disclosures, and State Negotiated Voluntary Disclosures.
Prior to joining Mahoney Sabol & Company, LLP, Mark spent over 20 years as Tax Manager and Tax
Director with large national and regional accounting firms, including Ernst & Young and Grant Thornton.
In addition, he has held responsible positions in corporate tax departments.
For additional information, readers can contact Mark Rousseau at 860-5412000, or email him at [email protected].
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© Copyright 2014. All rights reserved. Mahoney Sabol & Company, LLP. February 2014.
Mahoney Sabol & Company, LLP • 95 Glastonbury Blvd. • Suite 201 Glastonbury, CT 06033 • 860.541.2000