Are Worthless Stocks Tax Deductible?
The short answer is yes. Worthless stocks are tax deductible if they are truly worthless according to the Internal Revenue Service (IRS). This means they must not just be cheap or have lost most of their value. Worthless stock is literally illiquid, not trading, and carrying no value. The deduction can be claimed as either a short term or long term capital loss depending on whether you bought the stock in the tax year it stopped trading. It's also possible to write off stock you abandon without receiving any consideration, or stocks of companies that were liquidated and provided a refund below your cost basis.
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Identification
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One of the most important considerations when looking to deduct worthless stock is ensuring the stock is indeed worthless. A stock that has significantly lost value is not worthless if it is still trading for a few pennies, or even fractions of a penny. Generally, a stock that is still trading is not considered worthless. If a stock has stopped trading, it is treated for tax purposes as a sale on the last day of the tax year.
Liquidations
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In some cases, a failed company can be liquidated. If there is any capital remaining, it is distributed to shareholders as a special final dividend. In this relatively rare case, as a shareholder you would receive a 1099-DIV and the amount of the distribution can be used against your cost basis to calculate the loss. More likely, though, the stock will simply stop trading. Your broker might offer to buy the worthless shares from you for a nominal price to create a closing date and price for calculating a loss.
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Abandoned Shares
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It's also possible to deduct the value of shares abandoned after March 12, 2008. Abandoned shares are those in which you've surrendered all rights in and received no consideration for. This could occur as part of an irrevocable trust or other financial planning strategies. The IRS strictly examines all the circumstances surrounding the transaction to determine whether it is truly an abandonment rather than a sale, exchange or gift.
Reporting Loss
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The deduction for worthless stock is claimed on Schedule D of Form 1040. If the assumption of a sale on the last day of the year creates a short term capital loss, it is reported on line 1; if a long term loss, it is reported on line 8. In columns (c) and (d), indicating the date sold and the sale price, simply write "Worthless." The amount of the loss, the full cost unless some proceeds were received through a liquidation, is reported in parentheses in column (f). If the worthless stock was not declared in the year it stopped trading, it's necessary to file a 1040X amendment to your return to claim a refund.
Considerations
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One suggestion for dealing with worthless stock is to obtain the actual stock certificates from your broker and sell them to a friend or relative for a nominal price. Being sure to document the transaction by drafting a bill of sale, having your broker verify the signatures on the certificate and having a new certificate issued in the new owner's name, will establish a sale price on which you can calculate your loss on the stock. At the same time, in the off chance that the company comes back to life and the shares gain value, they will at least benefit your friend or relative.
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