An increasingly common occurrence at tax preparation companies is taxpayers claiming that stock they own is a worthless security. In some cases, the inaccuracy of such claims is easily verifiable. Companies involved in bankruptcy proceedings are not necessarily worthless. There are ways to verify that the stock of publicly owned companies is still traded. Identification of these situations is required by tax preparer ethics.
In order for a stock to become worthless, it must have zero value. If a company is privately held, a taxpayer may claim the stock is worthless if it stops operating. But the stock in these situations isn’t necessarily worthless. Before claiming worthless stock on a tax return, tax preparer jobs involve verification that the corporation has liquidated. Shareholders may still retain some value if a corporation has assets remaining.
No special documentation is required with a tax return reporting worthless stock. However, a common procedure in tax preparer employment is obtaining details about worthless stock in case there is ever any IRS questioning.
The IRS simply requires that cases of worthless stock involve no hope for an investor to receive any value. Reasonable determination of the date stock become worthless is also required.
Truly worthless stock is reported as a capital loss of the purchase price. Sales proceeds of zero dollars are recorded. The last day of the tax year is used as the closing date of the transaction. Completion of Schedule D uses December 31 as the sale date regardless of the day during the tax year that the stock became worthless. This can impact whether the loss is short-term or long-term. A registered tax preparer should place the word “worthless” on the Schedule D line used for the stock loss.
Discovery that a stock became worthless on a date in a preceding year requires an amended tax return. Amended tax returns filed using Form 1040X may claim a credit or refund due to the loss originating in a past year.
Contrary to the wishes of many taxpayers, the entire investment loss on worthless stock is not necessarily a tax deduction in the year of loss. Like all capital losses, there is a limitation of $3,000 per year that is deductible against other sources of income. However, the carryover of any excess is applied to capital gains in future years. Another $3,000 annually is also deducted against ordinary income until the carryforward is exhausted.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.
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