I incurred substantial capital losses in calendar year 2007. To use this capital losses, I am thinking of forming an S-Corp and getting a contract in the name of the S-Corp for some IT related work. I would withdraw some reasonable amount of salary every month from the contract revenue. Rest of the money I will leave in the company's account. After a year or two I will dissolve the S-Corp and take the money out. Would this be considered capital gains? Or is it just a stupid idea because I would be taxed for the complete income of the company during the year as the income of the company would automatically be reflected in my income.

There are some misconceptions on your understanding of the US tax code. First of all, you need to understand the concept of the treatment of capital losses.

Capital losses can only be offset against capital gains, and if there are none available, the taxpayer can only deduct $3,000 per year with the balance carried over to future years where taxpayers can use to offset against future capital losses or else deduct $3,000 per year and balance carried over as before.

Your idea of forming an S corporation to attempt to create a capital gains to offset against the capital losses is a flawed strategy and will not carry with the IRS.

The S corporation income is really taxed at the ordinary tax rate. Also, the S corporation is taxed as a flow through activity, and all residual income is reported on the K-1 as a distributable income to the shareholder on reported on Schedule E.

Hence, irrespective of whether or not you have taken a distributation or not, this so called residual income will be taxed at your ordinary tax.

Thus, there really would not be any capital gain attributable to the S corporation on the dissolution of this entity in 2 years. In fact, there probably will not be any capital gains at all available to offset the capital losses that will be carried over in 2 years.

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