- Chapter 7 bankruptcy liquidates all nonexempt assets and distributes them to creditors. When a corporation files for bankruptcy, this process can take more than a year. During that time, share prices quickly drop but may still trade for pennies even after liquidation begins. Shares are not liquidated because their value drops to close to zero once the company files for bankruptcy and are, therefore, worthless to creditors. Shareholders rarely get anything in a corporate Chapter 7.
- Most corporations in bankruptcy file for Chapter 11. Chapter 11 allows a corporation to reorganize its debts and operations. A trustee liquidates unprofitable parts of the company and pays creditors, who remain creditors of the reorganized company. In Chapter 11, corporations often recall all outstanding shares, cancel them and reissue new shares to creditors. Existing shareholders may receive some new stock but at a much lower value.
- When shares of a publicly traded company nose dive during bankruptcy or are canceled, shareholders can sell for pennies or ask their brokers for a document stating that the stock is worthless. Either the sale receipt or the broker's document, along with a record of the price the shareholder originally bought the stock at, serves as evidence for a capital loss on taxes. A shareholder can claim up to $3,000 in losses each year and use any extra loss in subsequent years. The IRS deducts capital losses from taxable capital gains, giving the taxpayer the first $3,000 in gains tax-free.
- When an individual files for Chapter 7, any nonexempt assets, such as stock, go into a separate bankruptcy estate. A trustee takes over the bankruptcy estate and sells everything, including any stock. The trustee also assumes responsibility for filing the taxes of the bankruptcy estate, such as capital gains taxes on the sale of stock. The person filing must supply all necessary records but does not have to file or pay taxes on any assets in the bankruptcy estate.
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