If you're looking for ways to entice friends and relatives to help capitalize your small company, you should know about Section 1244 of the Internal Revenue Code. The idea behind the legislation is to give a kind of investment insurance to anyone investing in a small, incorporated business.
The way it works is this: an investor who buys Section 1244 stock gets the best of all tax breaks: capital gains, which can be offset against capital losses if he sells the stock at a profit; and ordinary loss treatment if he sells at a loss or if the business fails and the stock becomes worthless. Ordinary losses are limited to $50,000 for single taxpayers and $100,000 for married taxpayers filing a joint return. But compare those numbers with the tax law's capital losses, which can be deducted only at the rate of $3,000 a year.
If you're incorporated, you can issue Section 1244 stock, provided the following four requirements are met at the time the time the stock is issued:
* Your company has received 50% of its gross receipt from operations -- as opposed to passive income such as interest and dividends -- for as long as it has been in business over the past five years.
* You issue the stock for cash or property, not stock or securities.
* Your company has received $1 million or less for its stock, including the Section 1244 stock, you're planning to sell.
* The stock is newly issued.
You can issue and sell Section 1244 stock to yourself as well as to outside investors. (For another use of 1244 stock, see "Costs of Business Searches," above.)