APPENDIX 17A

Cost of Capital and the Valuation of Worthless Stock1

Joanne Fong and Roger J. Grabowski

INTRODUCTION

When is a taxpayer allowed a worthless security deduction under IRC §165(g) of the Internal Revenue Code? Revenue Ruling 2003-125 (issued December 29, 2003) states the following:

[T]he shareholder of [an] entity is allowed a worthless security deduction under §165(g) . . . if the fair market value of the assets of the entity, including intangible assets such as goodwill and going concern value, does not exceed the entity's liabilities such that on the deemed liquidation of the entity the shareholder receives no payment on its stock.

Furthermore, courts have concluded that stock is worthless only when the underlying corporation lacks both liquidating value and potential value.2

The liquidating value concept generally addresses whether the aggregate fair market value of the underlying assets of the business is determined ...

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