Usually, you have to sell your stock before you can write off the loss on your taxes. However, not every publicly traded company stays in business. When a stock becomes worthless, the Internal Revenue Service allows you to write it off that year even though you haven't sold it. However, proving worthlessness isn't easy to do. There must be no hope of you ever recovering any money from the stock. For example, if a company is currently in a bankruptcy proceeding, you still have hope that you might get a little money or that the company can restructure in bankruptcy. If the company has dissolved, then you do have a worthless stock.
Calculate your holding period to determine whether the stock loss is a long-term loss, meaning you held the stock for more than a year, or short-term loss, meaning you held it for a year or less. The IRS rules require that you treat worthless stock as being sold on the last day of the year that it became worthless. For example, if you bought the stock on November 15, 2013, and becomes worthless on May 1, 2014, it's treated as being sold on December 1, 2014. This means that for tax purposes, you held it for more than one year, making it a long-term loss.
Report the loss on the appropriate section of IRS Form 8949. If it's a short-term loss, it goes in Part I. Report long-term losses on Part II. You need to report your basis -- what you paid for the stock -- as well as when you purchased it. Under the "Proceeds" column, write "Worthless."
Total your worthless stock as well as your other gains and losses and transfer the totals to Schedule D. The short-term gain and loss totals go in Part I and the long-term gain and loss totals go in Part II. Then, in Part III, you figure your total capital gains and losses.
Report your net capital gains or losses from Part III of Schedule D on line 13 of Form 1040. If you only have losses, your deduction is limited to $3,000 ($1,500 if you're married filing separately), but you can carry forward the excess losses to the next tax year.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."