Laboratory-testing company qualified as a section 1202 trade or business

Plain-English summary

Taxpayers sold stock in a company that used proprietary technology to perform specialized laboratory testing and report the results to healthcare providers. The company did not diagnose patients, recommend treatment, discuss patient care with providers, or explain results to patients. Its employees also used company-specific skills that were not useful to other employers. The IRS concluded that the company was not performing services in the field of health and did not principally depend on employee reputation or skill, so it was a qualified trade or business under section 1202(e)(3).

Ruling snapshot

• Question: Was the laboratory-testing company excluded from section 1202 because it performed health services or depended principally on employee reputation or skill?
• Outcome: approved, the company was a qualified trade or business under section 1202(e)(3)
• Key authorities: IRC §§ 1202(a), 1202(c)(2), and 1202(e)(3)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201717010                                             [Third Party Communication:
Release Date: 4/28/2017                                       Date of Communication: Month DD, YYYY]
Index Number: 1202.00-00
                                                              Person To Contact:
-----------------------------------------                     -------------------, ID No. -----------------
----------------------------                                  Telephone Number:
------------------------------------                          ---------------------
                                                              Refer Reply To:
                                                             CC:ITA:B04
In Re: -------------------------------------------------- PLR-125444-16
------------------------------------------------------------ Date:
------------                                                 January 23, 2017

LEGEND

Company = --------------------------------------------

Date 1 = ---------------------

Date 2 = ---------------------

Date 3 = ------------------

B = -------------------------------------------------------
------------

X = ------------------------------------------------------

z = --------------

Year 1 = -------




Dear -----------------------------:

This is in reply to your request for a ruling that gain from the sale of your stock in
Company qualifies for the partial exclusion of gain under § 1202(a)(1) of the Internal
Revenue Code because Company is a qualified trade or business as defined in
§ 1202(e)(3) and Company was not engaged in a “trade or business involving the
performance of services in the fields of health …” within the meaning of § 1202(e)(3)(A).
PLR-125444-16                                2

                                         FACTS

You owned stock in Company and filed a joint tax return. One of you was a founder of
Company and served as its chairman and CEO since its formation. You purchased
stock in Company on Date 1 and Date 2.

Company, a C corporation, was incorporated in Year 1 to develop a tool to provide more
complete and timely information to healthcare providers. 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.

You represent that the laboratory director is required to be an M.D., D.O. or a Ph. D. as
required by the laboratory personnel requirement of 42 C.F.R. § 493.1441 et. seq. The
lab director reviews results for quality control and quality assurance. You represent that
to the best of your knowledge, other than the laboratory director, Company’s laboratory
personnel are not subject to state licensing requirements or classified as healthcare
professionals by any applicable state or federal law or regulatory authority. You also
represent that laboratory director never has direct contact with patients and that none of
the Company’s personnel diagnose, treat or manage any aspect of any patient’s care.

You represent that Company’s employees, who are well educated, receive up to a year
of training to perform the X testing. However, you represent that the skills employees
bring with them when Company hires them are almost useless when performing the X
tests and that the skills they acquire at Company are not useful to other employers.
PLR-125444-16                                3


Company maintains a research division to develop additional uses for its proprietary
technology. Company has also developed additional uses for its X testing. For
example, it tests for z in food and agricultural products.

On Date 3, 100 percent of Company stock was acquired in a taxable transaction.

                                           LAW

Section 1202(a) provides, in general, that gross income does not include 50 percent of
any gain from the sale or exchange of qualified small business stock held for more than
5 years. Section 1202(a)(3) provides that in the case of qualified small business stock
acquired after the date of enactment of § 1202(a)(3) and on or before the date of
enactment of the Creating Small Business Jobs Act of 2010, § 1202(a)(1) shall be
applied by substituting “75 percent” for “50 percent” and § 1202(a)(2) shall not apply.

Section 1202(c)(2) provides that stock in a corporation is not treated as qualified small
business stock unless during substantially all of the taxpayer’s holding period for such
stock, the corporation meets the active business requirements of § 1202(e) and the
corporation is a C corporation.

Section 1202(e)(3) generally provides that a qualified trade or business means any
trade or business other than a 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, or any
trade or business where the principal asset of such trade or business is the reputation
or skill of one or more of its employees.

                                       ANALYSIS

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.
PLR-125444-16                                  4

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.

Thus, based on the facts and representations submitted, we conclude that for purposes
of § 1202(e)(3), 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.

                                      CONCLUSION

Based on the facts submitted, Company is engaged in a qualified trade or business
under § 1202(e)(3).

                                         CAVEATS

Except as expressly provided, in the immediately preceding paragraph, we do not
express or imply any opinion concerning the tax consequences of any aspect of any
transaction or item discussed or referenced in this letter under any provision of law
including § 1202.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

The rulings contained in this letter are based upon information and representations that
you submitted under penalties of perjury. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.

You must attach a copy of this letter to any income tax return to which it is relevant.
Alternatively, if you file your returns electronically, you may satisfy this requirement by
attaching a statement to the return that provides the date and control number of the
letter ruling.
PLR-125444-16                               5


In accordance with the Power of Attorney on file with this office, we are sending a copy
of this letter to your authorized representatives.

                                     Sincerely,



                                     Michael J. Montemurro
                                     Branch Chief
                                     Office of Associate Chief Counsel
                                     (Income Tax & Accounting)