Private Ruling Endorses Taxpayer-Friendly Reading of “Qualified Small Business” Under Section 1202

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On September 5, 2014, the Internal Revenue Service (“IRS”) released Private Letter Ruling 201436001 (the “Ruling”), which found that a company providing products and services primarily within the pharmaceutical industry was a “qualified trade or business” for purposes of Section 1202(e)(3). The IRS had never before issued guidance on the definition of “qualified small business stock” (“QSBS”) under Section 1202. A private letter ruling is not binding on the IRS except as to the taxpayer that requested and received the ruling, and cannot be relied upon as precedent by other taxpayers. Nonetheless, a private letter ruling typically provides all taxpayers with some indication of the IRS position on the particular legal issue that was addressed in the context of the facts contained in the ruling.

BENEFITS OF SECTION 1202 -

Section 1202 allows an individual shareholder who has held QSBS for more than five years to receive tax-reduced or tax-free gain up to the greater of $10 million or 10 times the shareholder’s basis in the QSBS. In order for a shareholder’s stock to qualify as QSBS, it must have been issued by a “qualified small business” (“QSB”) and it must have been acquired by the shareholder at original issuance (or in certain limited non-recognition transactions). Among other requirements, a corporation can be a QSB only if at least 80 percent of its assets are used in the active conduct of at least one “qualified trade or business.” The Ruling is of particular interest because it gives substantive consideration to the meaning of the term “qualified trade or business.”

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