Favorable IRS Ruling Issued on IRC Sec. 1202 Qualified Small Business Stock (QSBS)
- Jun 13, 2022
On May 27, the IRS released a favorable private letter ruling (PLR) – 202221006 – with respect to QSBS, IRC Sec. 1202. IRS rulings or guidance related to IRC Sec. 1202 are rare. In the PLR, the taxpayer was seeking to determine if its business is considered a qualified trade or business for purposes of IRC Sec. 1202.
The Benefits of IRC Sec. 1202
IRC Sec. 1202 was enacted in 1993 with the goal of encouraging long-term investment in startups and other small businesses by exempting capital gains from taxation on the sale of stock in these entities. IRC Sec. 1202 allows holders of QSBS to exclude 50% to 100% of capital gains on the sale of QSBS, provided the stock meets all of the following criteria:
- Issued by a domestic C corporation with no more than $50 million of gross assets at the time of and immediately after issuance;
- Issued by a corporation that uses at least 80% of its assets (by value) in an active trade or business, other than in certain personal service types of businesses;
- Issued after Aug. 10, 1993;
- Held by a non-corporate taxpayer;
- Acquired by the taxpayer on original issuance; and
- Held for more than five years.
The percentage of gain on the sale of QSBS excluded from federal income tax is determined as follows:
- QSBS issued from August 11, 1993 – February 17, 2009 = 50% gain exclusion;
- QSBS issued from February 18, 2009 – September 27, 2010 = 75% gain exclusion;
- QSBS issued from September 28, 2010 – Present = 100% gain exclusion.
The amount of gain eligible for exclusion is limited to the greater of $10 million or ten times the taxpayer’s basis in the QSBS.
In the PLR, a taxpayer is engaged in the retail sale of drugs. The business does not manufacture any of its drugs. Drug manufacturers generally prefer entering into exclusive distribution arrangements with companies. The taxpayer requested the PLR to determine whether its business is engaged in the field of health or a business where the principal asset is the reputation or skill of one of its employees, either of which would be disqualified under IRC Sec. 1202.
The IRS concluded in its PLR that for purposes of IRC Sec. 1202, the taxpayer is not in a business involving the performance of services in the field of health or where the principal asset is the reputation or skill of one or more of its employees.
The following reasons were stated by the IRS for its conclusion:
- Non-pharmacist employees are not certified health care providers and are not regulated under state or federal law.
- The pharmacists fill prescriptions provided by third-party health care professionals.
- Employees of the taxpayer have little to no contact or with third-party physicians, other than to receive prescriptions.
- All revenues are generated by the sale of the drugs. There is no revenue generated from medical care.
- The employees do not provide diagnostic services or medical care to its customers.
- The principal asset of the business is its exclusive drug distribution rights. Not the reputation or skill of one or more employees.
The PLR provided welcome insight into IRC Sec. 1202, a crucial tax provision with the potential to save eligible taxpayers millions in federal income tax. It is important to note that a PLR can only be cited as precedent for the requesting taxpayer but does give an indication of the position of the IRS.
What's on Your Mind?
Benjamin Aspir is a Partner 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.
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