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Interactive Guide to Qualified Trades or Businesses for QSBS Qualification

Interactive Guide to Qualified Trades or Businesses for QSBS Qualification

The following interactive guide reviews each piece of administrative guidance issued by the IRS on qualified trade or business status under IRC section 1202(e)(3). The descriptions of the business and the legal analysis are taken verbatim from the existing Private Letter Rulings (“PLRs”) and Chief Counsel Advice (“CCA”). Our commentary appears for underlined text and specific keywords can be highlighted in corresponding colors (mouse over the keyword set below to see total wordcount for each in the analysis; click to lock the highlights on). Readers with additional questions on qualified trade or business questions or QSBS more generally can contact Christopher Karachale and Andrew Schmidt.

Initial Comments on Qualified Trades or Businesses and IRS Guidance

The existing IRS guidance on qualified trades or businesses under IRC section 1202(e)(3) does not provide a consistent framework to help taxpayers understand which trades or businesses qualify and which do not. However, the guidance does reflect certain themes that help taxpayers ascertain whether a business meets the IRC section 1202(e)(3) requirements.

Most importantly, the test for qualified trades or businesses is qualitative, and not based on the facial language of the statute. For example, five out of the nine pieces of administrative guidance describe companies operating in the health field. But in each piece of guidance, the IRS concludes that the company in the health field still conducts a qualified trade or business. So a company that conducts business in one of the fields listed at IRC section 1202(e)(3)—for example health, consulting, financial services, or banking—is not barred from qualified trade or business status simply because it engages in a business activity involving one of the roughly 20 categories listed in the statute.

It is possible to pull out certain strands of consistent guidance among the PLRs and CCA that help elucidate which businesses are qualified trades or businesses. An overarching theme in the PLRs is that a qualified trade or business generally manufactures or creates an asset or IP that adds value for their customers.

So, in PLR 201436001, a pharmaceutical company that engaged in R&D for experimental drugs deployed “specific manufacturing assets and intellectual property assets to create value for customers,” and, therefore, did not perform services in the healthcare industry. Similarly, PLR 202144026 describes a medtech company that developed and commercialized software. The IRS found that the company was “not in the business of providing health services but rather creating an asset to be utilized by their customers in the healthcare industry.”

In more recent guidance, the IRS has provided analysis of other IRC section 1202(e)(3) categories, including brokerage services (PLR 202114002 and CCA 202204007), individual expertise (PLR 202319013), and consulting (PLR 202342014). These pieces of guidance also show that the IRS is focused on businesses that deliver tangible or intangible products, rather than simply services.

In CCA 202204007—the only existing adverse qualified trade or business administrative guidance—the IRS ruled that an online marketplace was engaged in brokerage services because it acted simply as an intermediary with a website that was “solely devoted to effectuating agreements” between landlords and potential tenants. However, the IRS seems to concede that had the online marketplace provided additional online content for customers, for example a “search engine that provides content to users and also sends targeted advertisements to those users based on their search history,” it could have been engaged in a qualified trade or business. The creation of a more robust online application, i.e., an asset to add value to the customers, might have avoided the brokerage service taint.

In PLR 202319013, the IRS describes a SaaS company that provided customers with proprietary service delivery processes and methodological packages. The company had highly trained employees who helped the company’s customers implement the technology. The IRS ruled that the employees’ technical skills and knowledge developed from training received using the company’s unique IP does not mean that the principal asset of a business is the reputation or skill of one or more employees. Similarly, in PLR 202342014, the IRS confirmed that even if a company’s employees provide advice and counsel related to data migration solutions, as long as those counseling services are ancillary to the company’s overall data migration business, then such professional services do not necessarily taint a company’s qualified trade or business status.

In both these rulings, it appears that the IRS is principally focused on whether the business is producing IP or some similar asset (e.g., SaaS delivery processes or data migration). The fact that a company may need highly skilled workers to implement that technology does not mean the companies are services companies excluded from IRC section 1202(e)(3) qualification.

Chronological List of IRS Guidance on Qualified Trades or Businesses

Appears 2 times  

analogue/analogous

Appears 12 times  

asset(s)

Appears 4 times  

intermediary

Appears 8 times  

software/intellectual property

Appears 3 times  

sole function/soley

Appears 6 times  

value

Appears 30 times  

service(s)

Appears 5 times  

(individual) expertise

Appears 12 times  

skill/skillset

Appears 11 times  

create/manufacture/
develop

Appears 3 times  

incidental/ancillary

Appears 5 times  

process(es)

 

PLR 201436001 PDF | May 22, 2014 | Health Field & Individual Expertise

J. Peter Baumgarten, Assistant to Branch Chief, Branch 4, Office of Associate Chief Counsel

Pharmaceutical Company: Company provides products and services primarily in connection with the pharmaceutical industry. In particular, Company works with clients to help commercialize experimental drugs. Its business activities include research, development, manufacture and commercialization. More specifically, its activities under these broad headings include (1) research on drug formulation effectiveness; (2) pre-commercial testing procedures such as clinical testing; and (3) manufacturing of drugs. In addition, Company works with clients to solve problems in the pharmaceutical industry, such as developing successful drug manufacturing processes. To perform these tasks, Company uses its physical assets, such as its manufacturing and clinical facilities, as well as its intellectual property assets, including its patent portfolio. Company’s successful performance of these activities in the past has earned the company several valuable relationships in the pharmaceutical industry.

ANALYSIS Section 1202(e)(3) excludes various service industries and specified non-service industries from the term “qualified trade or business.” Thus, a qualified trade or business cannot be primarily within service industries, such as restaurants or hotels or the providing of legal or medical services. In addition, § 1202(e)(3) excludes businesses where the principal asset of the business is the reputation or skill of one or more of its employees. This works to exclude, for example, consulting firms, law firms, and financial asset management firms.

Thus, the thrust of § 1202(e)(3) is that businesses are not qualified trades or businesses if they offer value to customers primarily in the form of services, whether those services are the providing of hotel rooms, for example, or in the form of individual expertise (law firm partners).

Company is not in the business of offering service in the form of individual expertiseThe IRS concludes that the Company is not in the business of offering services in the form of individual expertise, which is synonymous with reputation or skill of 1 or more of its employees.. Instead, Company’s activities involve the deployment of specific manufacturing assets and intellectual propertyCompare Pharmaceutical Distributor PLR where the asset of the company is its "distribution rights." assets to create valueCreating value is key to the analysis in this PLR, the Medical Device Fabricator PLR, and the MedTech PLR. Creating value appears to be the what distinguishes these company from companies just providing service in the form of individual expertise. for customers. Essentially, Company is a pharmaceutical industry analogueCompare Medical Device Fabricator PLR where the IRS analogizes the company to one doing custom manufacturing. of a parts manufacturer in the automobile industry.

Thus, although Company works primarily in the pharmaceutical industry, which is certainly a component of the health industry, Company does not perform service in the health industry within the meaning of § 1202(e)(3). Neither are Company’s business activities within any of the prohibited categories set forth in § 1202(e)(3).

Valid trade or business

 

PLR 201717010 PDF | Jan. 23, 2017 | Health Field & Reputation or Skill of 1 or More Employees

Michael Montemurro, Branch Chief, Office of Associate Chief Counsel

Laboratory Testing Company: Specifically, Company uses proprietary X and other technologies for the precise detection of B. [Taxpayer represents that] Company is the only person that can legally perform X testing and that its expertise is limited to its patented X testing.

Company analyzes the results of X testing and then prepares laboratory reports for healthcare providers. Company’s clients are doctors and other healthcare providers. [Taxpayer represents] that the information the Company provides in a typical laboratory report only includes a summary of z detected and z tested for and not detected. Company’s laboratory reports do not diagnose or recommend treatment. [Taxpayer represents] that Company does not discuss diagnosis or treatment with any healthcare provider, and is not informed by the healthcare provider as to the healthcare provider’s diagnosis or treatment. Company’s sole function is to provide healthcare providers with a copy of its laboratory report. Company receives compensation for reporting results of tests to healthcare providers, which is based on each test performed.

ANALYSIS Company provides laboratory reports to health care professionals. However, Company’s laboratory reports do not discuss diagnosis or treatment. Company neither discusses with, nor is informed by, healthcare providers about the diagnosis or treatment of a healthcare provider’s patients. Company’s sole functionCompare MedTech PLR where companies "sole function" is to provide tools in the form of software. Compare Online Marketplace CCA where company's webside is "solely" devoted to effectuating agreements between lessors and lesseee. is to provide healthcare providers with a copy of its laboratory report.

Company neither takes orders from nor explains laboratory tests to patients. Company’s direct contact with patients is billing patients whose insurer does not pay all of the costs of a laboratory test.

In addition, [taxpayer represents] that the skills employees bring to Company are not useful in performing X tests and that skills they develop at Company are not useful to other employers.

Further, none of Company’s revenue is earned in connection with patients’ medical care. Other than the laboratory director, Company’s laboratory technicians are not subject to state licensing requirements or classified as healthcare professionals by any applicable state or federal law or regulatory authority.

Although Company’s laboratory reports provide valuable information to healthcare providers, Company does not provide health care professionalsCompare Pharmaceutical Distributor PLR where company's employees do not provide any diagnostic services or medical care to either patients or physicians. with diagnosis or treatment recommendations for treating a healthcare professional’s patients nor is Company aware of the health care provider’s diagnosis or treatment of the healthcare provider’s patients. In addition, the skillsConsider that the "reputation or skill of one or more of" a business's employees is what makes it not a qualified trade or business. The PLR discounts the skills of employees of the Genetic Testing Company as applicable only for that business (not like law firm partners mentioned in the Pharmaceutical Company PLR). that Company’s employees have are unique to the work they perform for Company and are not useful to other employers.

Thus, based on the facts and representations submitted, we conclude that for purposes of § 1202(e)(3), Company is not in a trade or business (i) involving the performance of services in the field of health or (ii) where the principal asset of the trade or business is the reputation or skill of one or more of its employees.In the health field PLRs beginning with this one issued in 2017, the IRS concludes two-fold that the companies did not engage in a trade or business (i) involving the performance of services in the health field or (ii) where the principal asset of the trade or business is the reputation or skill of one or more of its employees.

Valid trade or business

 

PLR 202114002 PDF | Jan. 13, 2021 | Brokerage Services Field

John Aramburu, Senior Counsel, Branch 5, Office of Associate Chief Counsel

Insurance Agent: Business works with its customers to obtain insurance. Business generates revenue directly from the insurance company, often in the form of commissions and other similar compensation arrangements paid either directly from the insurance company or through withholding on a portion of a customer's premium payments. Contracts with insurance companies require Business to perform a number of administrative services. For example, Business must promptly report all known incidents, claims, suits and notices of loss to the insurance company or its designated claims adjuster and cooperate fully to facilitate any investigation, adjustment, settlement and payment of any claim. It also must keep true and complete records and accounts of all transactions and correspondence with the insureds at its principal office, which records and accounts must be open to examination, inspection, verification and audit by the insurance company upon reasonable notice.

ANALYSIS The term “brokerage services” is not defined in section 1202 or explained in the legislative history. The dictionary definition of “broker” defines the term as “one who acts as an intermediary: such as a: an agent who arranges marriages, b: an agent who negotiates contracts of purchase and sale (as of real estate, commodities, or securities).”

Business’s role is not that of a mere intermediaryMere intermediary status is key for determining a company is engaged in brokerage services. Compare Online Marketplace CCA where company was simply an intermediary between lessors and lessees.. Contracts with insurance companies require Business to perform a number of administrative services beyond those that would be performed by a mere intermediary facilitating a transaction between two parties.

For example, Business must promptly report all known incidents, claims, suits and notices of loss to the insurance company or its designated claims adjuster and cooperate fully to facilitate any investigation, adjustment, settlement and payment of any claim. It also must keep true and complete records and accounts of all transactions and correspondence with the insureds at its principal office, which records and accounts must be open to examination, inspection, verification and audit by the insurance company upon reasonable notice.

Valid trade or business

 

PLR 202125004 PDF | Mar. 29, 2021 | Health Field & Reputation or Skill of 1 or More Employees

Angella Warren, Branch Chief, Branch 4, Office of Associate Chief Counsel

Medical Device Fabricator: Taxpayer is in the business of manufacturing Class of Products as prescribed by third-party health care providers. Specialists employed by the Taxpayer work on prescriptions referred by health care providers to evaluate, measure, design, fabricate, manufacture, adjust, fit, and service Types of Products for the referred individuals. Taxpayer’s revenue is generated by the sale of these products. The sales generally consist of reimbursements from insurance companies, hospital systems, and patients.

ANALYSIS Taxpayer provides valueCompare Pharmaceutical Company PLR and MedTech Company PLR discussions of value. to its customers primarily in the form of a tangible product such as Class of Products. Taxpayer manufactures these products for individuals as prescribed by health care providers who are not employed by Taxpayer. While Taxpayer may directly interact with referred individuals and their respective diagnoses, the interaction is incidental in ensuring these individuals receive a Form of Product as provided by their prescription.

Taxpayer’s business is more analogousCompare Pharmaceutical Company PLR which was the analogue of a parts manufacturer in the automobile industry. to the business of custom manufacturing than to offering services based on individual expertise.

Although the Products produced by Taxpayer are associated with the health industry, we conclude that for the purposes of § 1202(e)(3), Taxpayer is not in the trade or business (i) involving the performance of services in the field of health or (ii) where the principal asset of the trade or business is the reputation or skill of one or more of its employees.

Valid trade or business

 

PLR 202144026 PDF | Aug. 10, 2021 | Health Field & Reputation or Skill of 1 or More Employees

Ronald Goldstein, Senior Technical Reviewer, Branch 4, Office of Associate Chief Counsel

MedTech Company: Taxpayer founded and incorporated Company to develop and commercialize software to assist medical providers in providing medical treatment to individual patients. The goal of the software is to make medical treatment more effective by optimizing the patient’s use of medical treatment or medication.

The software is a tool utilized by a medical provider and patients. The medical provider makes all medical decisions. Taxpayer represents that the Company does not practice medicine, has no patients, and is not licensed to issue prescriptions. The taxpayer also represents that the Company does not perform medical or laboratory tests and does not diagnose or recommend patient treatment.

ANALYSIS Company is a technology company which develops software for medical providers and patients to utilize as a tool in optimizing the patient’s treatment.

The softwareThe Online Marketplace CCA states that even though the company’s services are provided by software, the use of such software does not change the functional nature of the services. and reports do not diagnose or recommend treatment. These aspects of Company’s software illustrate that Company is not in the business of providing health services but rather creating an assetCompare Pharmaceutical Company PLR which used its manufacturing assets and IP assets to create value for customers. to be utilized by their customers in the healthcare industry.

Furthermore, Company is not a business that provides value to customers primarily in the form of individual expertise. Company is not licensed to issue prescriptions and perform medical tests. Company is not aware of and does not discuss the diagnoses or treatment by healthcare providers. The healthcare providers make all medical decisions. As such, it is the customers of Company who use their expertise to provide services in the healthcare industry.

Company’s sole functionCompare Genetic Testing Company PLR where the company's sole function was to provide lab reports and the MedTech PLR where the company's sole function was to provide tools int he form of software, applications, and reports. is to provide tools in the form of software, applications, and reports to create value for healthcare providers and their patients. Company is not a business whose principal asset is the reputation or skill of one or more employees. Although the software and applications developed by Company are allied or associated with the healthcare industry, we conclude that for the purposes of § 1202(e)(3), Company is not in the trade or business of performing services in the field of health or where the principal asset of the trade or business is the reputation or skill of one or more of its employees.

Valid trade or business

 

CCA 202204007 PDF | Nov. 4, 2021 | Brokerage Services Field

Erika Reigle, Senior Technical Reviewer, Branch 5, Office of Associate Chief Counsel

Online Marketplace: Corporation operates a website on which potential lessees may use the website to make nonbinding reservations for the use of certain facilities at specified rental rates from facility lessors that are included in the website data base. Corporation has no authority to enter into or sign leases on behalf of the potential lessors or lessees. A legally binding rental agreement for the use of a facility does not arise until the potential lessor and the potential lessee enter into a lease agreement. Corporation’s website will show a user that is considering leasing one or more facilities in a particular location the facilities in that area that are included in the website data base.

Potential lessees do not pay any fee to Corporation for the use of Corporation’s website.

The lessors are responsible for all payments to Corporation. Specifically, Corporation charges lessors a recurring periodic fee for simply being listed in the database, and a contingent fee based on a percentage of rent paid by a lessee actually leasing a facility from a lessor through a search of Corporation’s database.

ANALYSIS While Corporation states that it does not provide brokerage services but instead provides advertising services, it is our view that the actions and services provided by Corporation support our position that Corporation is a broker for purposes of § 1202(e)(3)(A).

A broker serves as an intermediaryCompare Insurance Agent PLR where the business did more than serve as a mere intermediary. between a buyer and a seller, and Corporation does this. Corporation does not just passively publish advertisements on its website that are provided to it from potential lessors desiring to lease property. Unlike a search engine that provides content to users and also sends targeted advertisements to those users based on their search history, Corporation’s website is solely devoted to effectuating agreements between potential lessors and potential lessees of certain property.

Corporation charges a minimum flat fee to lessors irrespective of whether a potential lessor succeeds in entering into lease agreements as a result of the use of Corporation’s website. However, Corporation is also compensated on a commission basis based on leasing transactions that are entered into as the result of the use of Corporation’s website.

Corporation does not have the authority to enter into leasing agreements on behalf of lessors that use its services. Corporation only provides a vehicle for potential lessees to transmit non-binding reservation requests to potential lessors. Only the potential lessor and lessee have the authority to enter into a binding lease agreement. However, brokerage activity can include simply bringing a potential buyer and seller together to work out the transaction.

The fact that Corporation’s services are provided by softwareCompare Medtech PLR where development of software was integral to showing that company was not in the health field. created by people rather than directly by people does not change the functional nature of the services. Because Corporation provides brokerage services within the meaning of § 1202(e)(3)(A), taxpayer is not entitled to exclude any of the gain from the sale of stock in Corporation under § 1202.

Not valid trade or business – activities constitute brokerage services

 

PLR 202221006 PDF | Mar. 3, 2022 | Health Field & Reputation or Skill of 1 or More Employees

Erika Reigle, Senior Technical Reviewer, Branch 5, Office of Associate Chief Counsel

Pharmaceutical Distributor: Taxpayer (corporation) is only involved in the retail sale of a limited number of drugs and does not manufacture them. The manufacturers of these drugs prefer entering into exclusive distribution arrangements with companies such as Taxpayer.

Employees of Taxpayer include several pharmacists who fill prescriptions received from physicians. Other employees coordinate the insurance coverage with respect to such prescription orders. Once the insurance process is complete and the prescription is filled by the pharmacist, Taxpayer mails the prescription to the patient’s home. Pharmacists and other employees of Taxpayer have no contact or interaction with physicians, other than to receive prescriptions from them. With respect to patients, pharmacists interact with patients only if a patient has a question about a particular prescription. Employees are never involved in diagnosing any medical issues or recommending any treatment or drug to individuals. Their interaction with patients is limited to the filling and maintenance of prescriptions as ordered by a physician. Therefore, none of Taxpayer's employees diagnose, treat or manage any aspect of any patient's care.

Taxpayer's revenues are strictly related to the sale of such drugs, and Taxpayer earns no revenues in connection with the medical care of patients.

ANALYSIS Taxpayer's employees are not engaged in the provision of medical services. Other than the pharmacists, such employees are not certified healthcare providers and are not otherwise regulated under state or Federal law. Taxpayer's pharmacists fill prescriptions provided by health care professionals, and other employees help manage the insurance process and occasionally communicate with patients regarding prescription issues and timely refill requests. Any interaction with patients regarding their prescriptions is merely incidental to ensuring receipt of their required prescriptions or answering a patient’s question about them. Taxpayer’s employees do not provide any diagnostic services or medical care to either patients or physicians, and all revenues are generated by the sale of the drugsNote that no other PLR references the source of revenue as a factor in determining whether the company is a valid qualified trade or business.. Also, Taxpayer’s principal asset is not the reputation or skill of one or more employees, but its exclusive pharmaceutical distributionCompare Pharmaceutical Company PLR where the company created manufacturing assets and IP rather than simply had an exclusive distribution right. rights.

We conclude that for the purposes of section 1202(e)(3), Taxpayer is not in a trade or business (i) involving the performance of services in the field of health or (ii) where the principal asset of the trade or business is the reputation or skill of one or more of its employees.

Valid trade or business

 

PLR 202319013 PDF | Feb. 14, 2023 | Reputation or Skill of 1 or More Employees

Erika Reigle, Senior Technical Reviewer, Branch 5, Office of Associate Chief Counsel

Software Company: Company is an enterprise cloud application services software company, which provides solutions tailored to the operating functions and industry-specific challenges of their clients. The Company's employees possess technical skills and knowledge which allow for effective implementation and the quality of the Company's services. However, they are trained on one or more of the Company's proprietary service delivery processes and methodology packages that are unique to the Company and may not be utilized by the employees at any other employers that may provide the same or similar service. The Company can recruit and train new employees with the required technical skillset to perform substantially identical services using its methodology packages.

ANALYSIS The Company's employees possess technical skills and knowledge due to training receivedCompare to PLR 201717010 where a genetic technology company's employees' skills are unique to the work performed for the company and are not useful to other employers. Here, the technical skillset acquired by employees does not rise to the level in the form of individual expertise. on one or more of the Company's proprietary service delivery processes and methodology packages. Such processes and packages are unique to Company and may not be utilized by the employees at other similar companies. The Company can recruit and train new employees with the required technical skillset to perform substantially identical services using its methodology packagesPLR 201436001 explained that companies providing value to customers primarily in the form of individual expertise, like a law firm partner, are not qualified trades or businesses. This PLR explains that where employees acquire technical skills and knowledge through training provided by the company, those skills and expertise do not taint qualified trade or business status.. Therefore, the principal asset of the Company is not the reputation or skills of one or more employees, but the intellectual property held by the Company itself in its proprietary service delivery processes and methodology packages.

Valid trade or business

 

PLR 202342014 PDF | July 24, 2023 | Consulting Field

Erika Reigle, Senior Technical Reviewer, Branch 8, Office of Associate Chief Counsel

Software Company: Company offers data migration and management services to businesses. It does not sell software or technical equipment as part of the services it provides. To understand its customers' needs, Company creates a transformation assessment plan. Its service delivery teams determine an optimized cloud and data transformation roadmap based on assessment outcomes. Company team members will integrate into the customer's team often on a full-time basis to orchestrate and troubleshoot the data migration and work to implement the data migration, as well as provide limited advice and counsel when working with a customer’s team. Company also provides post-migration managed technical services, which include monitoring and resolving incidents. The invoices provided to Company's clients for the services it performs represent billing for implementation services and embedded advice. Company does not separately bill for advice and counsel.

ANALYSIS Company’s employees provide advice and counsel as part of the process of determining a client’s data management needs but the advice and counsel is ancillary toAlthough a company provides services in the form of advice and counsel when implementing data management solutions, such services are merely ancillary or incidental to the software company's software implementation work. and supports the sale of the implementation work Company’s employees perform. Company does not separately bill for advice and counsel, but only for its final product of implementing data management solutions. Therefore, Company does not engage a trade or business involving the performance of services in the field of consulting.

Valid trade or business

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For More Information, Please Contact:

Christopher Karachale
Christopher Karachale
Partner
San Francisco, CA
Andrew Schmidt
Andrew Schmidt
Associate
Sacramento, CA

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