IRS rules favorably on QSB stock exclusion

The IRS has issued a private letter ruling (PLR 202342013) holding that a corporation was engaged in a qualified trade or business for purposes of the qualified small business (QSB) stock exclusion under Section 1202, disregarding advice and counsel as ancillary to the qualified provision of goods and services. The ruling provides a favorable interpretation of the definition of “services in the field of consulting,” which are disqualified.

Section 1202 allows shareholders to exclude gain from the sale of qualified small business (QSB) stock held for five years if certain requirements are met at both the shareholder and corporate level. One of the most complex requirements mandates that the corporation must use at least 80% of its assets (by value) in the active conduct of one or more qualified trades or businesses. “Qualified trade or business” is defined through exclusion, with a list of categories of businesses that are not qualified trades or businesses, including any trade or business involving the performance of services in the field of consulting. There is no definition of “consulting” for Section 1202 purposes in the statute or in regulations.

The letter ruling addresses a corporation that offers data migration and management services to businesses. The corporation does not sell software or technical equipment as part of the services it provides. To understand its customers' needs, the corporation creates a transformation assessment plan. Its staff determines an optimized cloud and data transformation roadmap based on assessment outcomes. The corporation’s staff works with its customer’s teams to orchestrate and troubleshoot the data migration and work to implement the data migration, as well as provide limited advice and counsel. The corporation also provides post-migration managed technical services, which include monitoring and resolving incidents. The ruling notes that invoices provided to the corporation’s clients for the services it performs represent billing for implementation services and embedded advice, and advice and counsel are not separately stated on invoices.

The IRS ruled that the corporation was engaged in a qualified trade or business as defined in Section 1202(e)(3) and specifically ruled that the corporation was not in a trade or business involving the performance of services in the field of consulting.

Although private letter rulings may not be used or cited as precedent by other taxpayers, the conclusion in this ruling provides insight into the IRS’s interpretation of the definition of “services in the field of consulting.” The IRS appears to adopt an approach of disregarding advice and counsel that is ancillary to the provision of goods and services that constitute qualified trades or businesses. The manner in which a corporation is paid for services looks to have informed this conclusion, so the way in which a company invoices for its goods and services may carry some weight.

Historically, in its rulings on whether a corporation is engaged in qualified trade or business, the IRS has disregarded the regulations under Section 199A, which cross-reference the Section 1202 list of excluded trades or businesses in defining its own list of “specified services trades or business.” Many of the excluded businesses, including services in the field of consulting, have expansive definitions within the Section 199A regulations. Although PLR 202342013 does not explicitly reference the Section 199A definition, the facts relied on in the ruling provide some indication that the IRS was applying an analytical approach that echoes the language of the regulations under Section 199A.