Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 75-13

1975-1 C.B. 67

Sec. 501

IRS Headnote

Worthless corporate stock held by corporate officer; ordinary v. capital loss. An officer-stockholder of a stock brokerage and investment banking firm who voluntarily purchased his stock in the corporation during its period of prosperity and rapid growth when the stock appeared to be an attractive investment sustained a capital loss rather than an ordinary loss in the year the corporate stock became worthless.

Full Text

Rev. Rul. 75-13

Advice has been requested whether, under the circumstances described below, an individual sustained an ordinary loss or a capital loss in the year certain shares of his corporate stock became worthless.

In 1960 the taxpayer began his employment with an incorporated stock brokerage and investment banking firm. He became an officer of the corporation in 1962. In the period 1962 to 1968 the taxpayer's employer experienced extremely rapid growth and high prosperity, and the firm was generally regarded as having a high potential for continued good performance. However, beginning in 1968 the firm encountered difficulties so serious that in 1970 the firm ceased all normal business operations and began to liquidate.

Subsequent to his promotion in 1962 the taxpayer first purchased stock in his employer. The employer encouraged officers to make such purchases on the theory that the officers would work more efficiently if they had a financial stake in the success of the corporation. The purchases were not mandatory, but the officers considered such purchases to be potentially helpful in advancing their positions within the corporation.

The taxpayer received additional promotions after 1962, and shortly after receiving some of the promotions he purchased varying amounts of stock. His last purchase was in December 1967, and he was in a position to know the full extent of the firm's difficulties that began in 1968. Despite ceasing his stock purchases, the taxpayer received two significant promotions in the next two years. The taxpayer's salary tripled in the period 1962 to 1970.

The taxpayer's stock became worthless in 1970 when it became clear that the stock had no present or potential liquidation value.

Section 165(a) of the Internal Revenue Code of 1954 provides that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 165(c) provides, in part, that in the case of an individual, the deduction under subsection (a) shall be limited to: (1) losses incurred in a trade or business; and (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business.

Section 165(f) of the Code provides that losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in sections 1211 and 1212. Section 165(g) provides, in part, that if any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall be treated as a loss from the sale or exchange of a capital asset.

Section 1221 of the Code provides that the term "capital asset" means property held by the taxpayer, subject to five specific exceptions, none of which is applicable here. The Supreme Court of the United States has held, however, that certain property used as an integral part of a taxpayer's trade or business, even though not of a kind listed in the specific exceptions, is nevertheless not a capital asset. In Corn Products Refining Co. v. Commissioner, 350 U.S. 46 (1955), 1955-2 C.B. 511, the Court said that Congress intended that profits and losses arising from the everyday operation of a business should be considered as ordinary income or loss rather than capital gain or loss. Thereupon, the Court held that sales of corn futures by a manufacturer of products made from grain corn resulted in ordinary gains and losses and not capital gains and losses, because the corn futures were purchased as a part of the company's corn buying program.

In the light of the Corn Products case, subsequent courts have indicated that whether the sale or exchange of shares of stock gives rise to ordinary, as opposed to capital, gain or loss depends upon whether the taxpayer purchased and held the stock with a predominant business motive as distinguished from a predominant investment motive. Motive is determined by analyzing all the surrounding facts and circumstances. United States v. Generes, 405 U.S. 93 (1972), 1972-1 C.B. 61; Booth Newspapers, Inc. v. United States, 303 F.2d 916 (Ct. Cl. 1962).

In the present case, the purchase of stock in the employing corporation was not prerequisite to employment nor a requirement for retention of position or for promotion. All of the purchases of stock took place during the time when the corporate employer was prosperous and growing rapidly, so that the stock appeared to be an attractive investment. In no sense may the purchase and holding of the stock in this case be said to have occurred in the everyday operation of the taxpayer's business as a corporate executive so as to constitute an integral part thereof within the meaning of the Corn Products decision. The circumstances of this case indicate that investment rather than business was the predominant purpose for the purchase and holding of the stock. Accordingly, the taxpayer sustained a capital loss in the year the corporate stock became worthless.