The IRS recently issued a private letter ruling (PLR 201717010
), in which it determined that a corporation that uses proprietary technology to perform certain medical tests is engaged in a qualified trade or business for purposes of Section 1202.
In general, Section 1202(a) provides that gross income does not include some or all of the gain from the sale or exchange of qualified small business stock (QSBS) held for more than five years. The gain exclusion under Section 1202 is 50% for stock acquired before Feb. 18, 2009, 75% for stock acquired between Feb. 19, 2009, and Sept. 27, 2010, and 100% for stock acquired on or after Sept. 28, 2010.
Generally, QSBS is defined as stock of a qualified small business. One of the requirements a corporation must meet to be considered a qualified small business is that at least 80% of its assets are used in the active conduct of one or more qualified trades or businesses. Certain businesses are statutorily disqualified as active trades or businesses, including those involving the performance of services in the field of health and those in which the principal asset is the reputation or skill of one or more of its employees.
In the facts of the PLR, the company developed a proprietary tool to perform certain medical tests. The company’s employees analyze the results of the tests and prepare laboratory reports for healthcare providers. Those laboratory reports do not diagnose or recommend treatment, and the company does not discuss diagnosis or treatment with patients or with the healthcare providers who commission the tests. The IRS noted that the company’s employees are well educated, but the pre-existing skills they bring to the company are not useful to the company in performing its particular medical tests.
Noting the lack of diagnosis or treatment services performed by the company, as well as the fact that the skills of the company’s employees are not useful to other employers, the IRS determined that the 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.” Based on that determination, it concluded that the company was engaged in a qualified trade or business for purposes of Section 1202.
Thus, the company satisfied the qualified trade or business test, and to the extent the company and its shareholders otherwise satisfied the remaining requirements under Section 1202, such shareholders would be eligible to exclude some or all of their gain from the disposition of the company’s stock.
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