I own stock that became worthless last year. Is this a bad debt? How do I report my loss?

Owning stock that becomes worthless is not considered a bad debt. According to the Internal Revenue Code and Treasury Regulations, worthless securities, including stocks, are treated differently from bad debts.

Legal Reasoning and Rationale:

1. Definition and Treatment of Worthless Securities:
   • Under "Subsection 165(g): Worthless securities," if any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom is treated as a loss from the sale or exchange of a capital asset on the last day of the taxable year.
   • "Subsection 1.165-5(a): Definition of security" specifies that a security includes a share of stock in a corporation.
   • "Subsection 1.165-5(c): Capital loss" further clarifies that if a security which is a capital asset becomes wholly worthless, the loss may be deducted as though it were a loss from a sale or exchange of a capital asset.
2. Reporting Worthless Securities:
   • According to the IRS FAQ and Publication 550, worthless securities should be reported on Form 8949, Part I or Part II, depending on whether the loss is short-term or long-term. The holding period determines this classification.
   • The instructions for Form 8949 (2023) also indicate that nonbusiness bad debts must be treated as short-term capital losses, but this does not apply to worthless securities, which are treated as capital losses from the sale or exchange of a capital asset.
3. Specific Exclusions and Clarifications:
   • "Subsection 1.165-5(i): Abandonment of securities" states that a security that becomes wholly worthless includes one that is abandoned, provided it meets the requirements for a deductible loss under section 165.
   • The IRS FAQ and Publication 550 emphasize that you must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for it to qualify as abandoned.

Direct Answer to the Question:

No, owning stock that became worthless last year is not considered a bad debt. Instead, it is treated as a capital loss from the sale or exchange of a capital asset.

How to Report the Loss:

1. Determine the Holding Period:
   • Treat the worthless stock as if it were sold on the last day of the tax year. Determine if the loss is short-term (held for one year or less) or long-term (held for more than one year).
2. Form 8949:
   • Report the worthless stock on Form 8949, Part I or Part II, depending on the holding period. Use the appropriate code for worthless security deduction in the applicable column of Form 8949.
3. Additional Forms:
   • If you did not claim the loss on your original return, you can file an amended return using Form 1040X within the specified time limits.

By following these steps, you can accurately report your loss from worthless stock on your tax return.

Sources:
Publication 550 (2023)
§ 165. Losses
§ 1.165-5. Worthless securities.
The Worthless Stock Deduction
Instructions for Form 8949 (2023)
Economic Downturns and Worthless Stock Deductions