Does section 1244 apply to S corporation stock?

Yes. §1244(c)(1) requires stock in a domestic corporation, and an S corporation qualifies just like a C corporation. The §1244 loss on your stock is separate from the pass-through losses you may have deducted along the way, and your stock basis, already reduced by those losses, sets the size of the final loss.

Is claiming a section 1244 ordinary loss an audit red flag?

A six-figure ordinary loss on Form 4797 gets read, and the IRS wins these cases on documentation, not theory. You need proof of original issuance, what you paid and in what form, the corporation's total capital at issuance under the $1,000,000 test of §1244(c)(3), and its gross receipts mix. With those records the position is solid; without them it folds.

Can the same stock qualify for both QSBS and section 1244?

Yes, and for founders it usually should. Section 1202 excludes gain if the company succeeds and you hold five years; §1244 converts up to $100,000 per year of loss to ordinary if it fails. The requirements overlap heavily around original issuance from a domestic C corporation, so the same formation records support both.

When is stock officially worthless for the deduction?

In the year it becomes wholly worthless, with §165(g) treating it as sold on December 31 of that year. Worthless means no current or potential value: a dissolution, liquidation, or cessation of business with liabilities exceeding assets is the usual proof. Claiming while the company still operates invites a challenge that it was too early.

What happens to the loss above the $100,000 section 1244 cap?

It stays a capital loss under the normal rules: it offsets capital gains dollar for dollar, then up to $3,000 of ordinary income per year under §1211, and the rest carries forward indefinitely. On a joint return, only the first $100,000 of loss in a single year gets the ordinary-loss upgrade under §1244(b).

The Journal / Business Tax

Section 1244 Stock: The $100,000 Ordinary Loss When a Startup Fails.

By Ewan Morkel, EAJuly 19, 20266 min read

Capital losses die against wages at $3,000 a year. Section 1244 converts up to $100,000 of a failed corporation's stock loss into an ordinary deduction in a single year, if the stock was set up right when it was issued.

A married couple put $150,000 into a logistics startup one of them cofounded: a C corporation, cash for stock at incorporation, four years of grinding, then a quiet dissolution in 2026. The default tax treatment of that outcome adds insult to the loss. A capital loss offsets capital gains and then chips away at ordinary income at $3,000 a year under §1211; with no gains to absorb it, $150,000 takes fifty years to deduct. A section 1244 stock ordinary loss is the exception Congress wrote for exactly this failure, and it puts up to $100,000 of the loss against their W-2 income in year one.

The tests

What makes a loss a section 1244 stock loss.

There is no election and nothing to file when the stock is issued. Qualification under IRC §1244 is proved after the fact, from records, and every test looks backward to the issuance date:

Original issuance. The corporation issued the shares to you, as an individual or through a partnership. Stock bought from a cofounder, inherited, or received by gift never qualifies, no matter how small the company.
Money or property paid in. Shares issued for services, or in exchange for other stock or securities, are excluded by §1244(c)(1)(B). The founder who paid cash qualifies; the advisor who got shares for work does not.
The $1,000,000 test. Aggregate money and property the corporation received for stock, measured when your shares were issued, cannot exceed $1,000,000 (§1244(c)(3)). The first $1,000,000 of a larger raise can still qualify, with the corporation designating which shares.
An operating business. For the five tax years before the loss, the corporation must have drawn more than 50% of gross receipts from sources other than royalties, rents, dividends, interest, annuities, and securities sales (§1244(c)(1)(C)). Holding companies fail; delivery companies pass.
Any class of stock, mostly. Common always qualifies; preferred qualifies only if issued after July 18, 1984.

C corporations and S corporations both count, since the statute just says domestic corporation. An LLC taxed as a partnership has no stock at all, so §1244 never applies to it, which belongs on the long list of things to price into the entity choice. Because qualification rides on records, keep the incorporation documents, the cap table, the wire confirmations, and the receipts history somewhere that survives the company. The burden of proof sits on the shareholder claiming the loss.

The cap

The annual limit, and the year everything happens.

The $50,000 and $100,000 caps in §1244(b) are per year, not per lifetime, which matters because you rarely control the year. Wholly worthless stock is treated as sold on the last day of the year it becomes worthless under §165(g), so a 2026 dissolution fixes the whole loss in 2026, and a married couple deducts $100,000 as ordinary loss with the remaining $50,000 falling back to capital. A sale you control is different: sell half the position in December and half in January and each year gets its own cap. A dead company does not offer that choice. One more feature that surprises people: under §1244(d)(3) the ordinary piece counts as a business loss for net operating loss purposes, so it is not wasted even in a year with little other income.

A $150,000 founder investment gone to zero, married filing jointly, 2026.

Cash paid for stock at incorporation: $150,000
Stock becomes wholly worthless in 2026 (§165(g)): ($150,000)
Ordinary loss under §1244(b), joint return cap: $100,000
Capital loss (the remainder): $50,000
Federal tax saved by the ordinary piece (35% bracket): $35,000
Years to deduct $150,000 as pure capital loss, no gains: 50

Tax year 2026. Assumes a 35% marginal bracket, no capital gains to absorb the loss, and stock that meets every §1244 test. The $50,000 capital remainder still offsets future capital gains in full or ordinary income at $3,000 a year under §1211.

The paperwork

Where the loss goes on the return.

The ordinary portion is reported on Form 4797, Part II, line 10, labeled as a section 1244 loss; the excess goes to Schedule D like any capital loss. The year of worthlessness takes some discipline: claim it while the company still has a pulse and the IRS can argue the stock had value; wait too long and the year is closed. A dissolution filing, a liquidation, or a formal abandonment makes the timing defensible. This is also the moment to check the other small-business-stock provision in your file, because the two are a matched set: §1202 shields the win, §1244 cushions the loss, and the same original-issue C corporation stock can carry both tags. Founders should read the QSBS rules after OBBBA on the way up and keep the 1244 records in case of the way down. And if the company burned cash on R&D before it died, the section 174 refund rules may be worth money before any of this matters.