Recent IRS Ruling Provides Clarity into IRC Sec. 1202 – Qualified Small Business Stock

March 03, 2022

By Benjamin Aspir

In late January 2022, the IRS released Private Letter Ruling (PLR) 202204007 in response to a request by a business seeking to determine if it is considered a qualified trade or business under IRC Sec. 1202. A PLR is a written statement issued to a taxpayer (upon request) that interprets and applies tax laws to the taxpayer’s represented set of facts. The PLR provides IRS insight into IRC Sec. 1202, a crucial tax provision.

IRC Sec. 1202

IRC Sec. 1202 was enacted with the goal of encouraging long-term investment in startup companies and other small businesses by exempting capital gains taxes upon the sale of stock in these entities. Accordingly, IRC Sec. 1202 allows holders of qualified small business stock (“QSBS”) to exclude 50% to 100% of capital gains upon the sale of QSBS provided the stock meets all of the criteria of IRC Sec. 1202. IRC Sec. 1202 allows eligible taxpayers to exclude the greater of $10 million or 10 times the taxpayer’s basis in the QSBS sold.

PLR 202204007

In the PLR, a taxpayer operates a business that facilitates the leasing of property between lessors and lessees requested a PLR to determine whether their business is engaged in the field of “brokerage services,” which would not be a qualified trade or business for purposes of IRC Sec. 1202.

The taxpayer’s website allows potential lessees to make non-binding reservations for the use of certain facilities at specified rental rates from lessors in the website database. The taxpayer has no authority to enter into or sign leases on behalf of the potential lessors or lessees. Potential lessees do not pay any fee to the business for the use of its website.

The taxpayer charges lessors a recurring fee for being listed in the database, and a contingent fee based on a percentage of rent paid by a lessee leasing a facility from a lessor through the database. The taxpayer asserted to the IRS that it is not a broker with respect to the leasing of the facilities. The taxpayer also provided other services to lessors such as website building and hosting to be used in conjunction with the leasing of the lessor’s facility.

The Internal Revenue Code does not define the term brokerage services in the context of IRC Sec. 1202. Therefore, the IRS turned to several other Code sections and tax regulations that discuss the definition of “brokerage services” (IRC Secs. 199A, 448 and 6045). Additionally, the PLR discussed the dictionary definition of the word “broker.”

The IRS concluded in its PLR that the taxpayer should be classified as a broker under the common meaning of the term and as it is defined under IRC Sec. 6045, rather than the narrower definition that applies to IRC Sec. 199A. The IRS disagreed with the taxpayer’s assertion that its website merely provided an advertising service and was not a broker.

The IRS stated the following reasons for its position:

  • The taxpayer did not merely passively publish advertisements on its website.
  • The taxpayer’s website was solely devoted to effectuating agreements between potential lessors and potential lessees of certain property.
  • The taxpayer was compensated on a commission basis based on leasing transactions that were entered into as the result of the use of its website.
  • The taxpayer did not have the authority to enter into leasing agreements on behalf of lessors that use its services
  • The website was merely a vehicle for potential lessees to transmit non-binding reservation requests to potential lessors.

While the ruling is not favorable for the taxpayer, it provides much needed clarity on the rules of QSBS. It is important to note that a PLR can only be cited as precedent for the requesting taxpayer. A tax professional should be consulted in order to determine potential IRC Sec. 1202 eligibility.


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About Ben Aspir

Benjamin Aspir is a Senior Manager and a member of the firm’s National Tax Group, with more than 10 years of public accounting experience. He has extensive experience with IRC Section 1202 - Qualified Small Business Stock and advising cannabis clients on IRC Section 280E, within the Manufacturing and Distribution practice.