The exclusion for gain from the sale of qualified §1202 stock now is at 100% for stock acquired after September 27, 2010 so long as the taxpayer holds it for five years. But a number of businesses are excluded from issuing such favored stock. In PLR 201717010 the IRS looks at whether a taxpayer’s business would cause it to fail the test.
The potential benefit of §1202 is one of the reasons a small business might still consider forming as a C corporation (S corporation stock does not qualify for §1202 treatment) if it can otherwise meet the requirements, which will include a limit on gross assets, an “active business” test and the business cannot be on the list of “prohibited” businesses found at IRC §1202(e)(3).
The businesses that cannot qualify for §1202 stock treatment are:
- Any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services,
- Any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees,
- Any banking, insurance, financing, leasing, investing, or similar business,
- Any farming business (including the business of raising or harvesting trees),
- Any business involving the production or extraction of products of a character with respect to which a deduction is allowable under section 613 or 613A (percentage depletion), and
- Any business of operating a hotel, motel, restaurant, or similar business.
This PLR involved a business that was concerned it might be deemed to be performing health services and sought a ruling that its operations were not health services for purposes of IRC §1202.
The Company’s business is described in the ruling as follows:
Specifically, Company uses proprietary X and other technologies for the precise detection of B. You represent 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. You represent 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. You represent 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.
Company accepts orders for tests only from health care professionals. Patients cannot order tests from Company. Although Company in rare instances may provide a copy of a test to a patient, it does not explain its laboratory reports to patients. Instead, Company directs patients to contact their healthcare provider if they have any questions. The only other contact Company has with a patient is in billing situations. Company will bill a patient directly if the patient is self-insured, uninsured, or if the insurance company pays the patient directly.
The IRS agreed with the taxpayer’s view that its business did not qualify one providing health services as that term is defined for IRC §1202 purposes. The IRS’s answer helps outline what the Service saw as key factors that made this organization not a health care business:
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 function 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, you represent 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 professionals 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 skills that Company’s employees have are unique to the work they perform for Company and are not useful to other employers.
Unfortunately, the ruling talks about so many factors that it’s clear exactly which ones were key to the decision. But most of the factors concentrate on the fact that the organization did not deal directly with patients, but rather only performed their services for licensed healthcare professionals. Clearly, if the business had provided a diagnosis, treatment recommendation or had dealt directly with the public it seems very possible the answer would have been different.