Medical product manufacturer is a qualified trade or business

Plain-English summary

A domestic C corporation manufactured custom products prescribed by independent health care providers. Its employees evaluated and fitted individuals for the products, but the corporation earned its revenue from selling the tangible products. After its stock was sold, the taxpayer asked whether the business qualified for the Section 1202 exclusion rather than falling within the excluded field of health services. The IRS ruled that the corporation was a qualified trade or business under Section 1202(e)(3). Its customer interactions were incidental to delivering prescribed products, and its business resembled custom manufacturing rather than services based on employee expertise. The ruling did not decide whether every other requirement for excluding gain on the stock sale was met.

Ruling snapshot

• Question: Is a manufacturer of custom medical products a qualified trade or business for the Section 1202 stock-gain exclusion?
• Outcome: Approved. The business is not an excluded health service or a business whose principal asset is employee reputation or skill.
• Key authorities: IRC §§ 1202(a), 1202(c)(2), 1202(e)(1), 1202(e)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202125004 [Third Party Communication:
Release Date: 6/25/2021 Date of Communication: Month DD, YYYY]
Index Number: 1202.00-00
Person To Contact:
-------------------------------------------- ---------------------------, ID No. ---------------
-------------------------------------- -----------------
---------------------------------- Telephone Number:
--------------------
---------------------------- Refer Reply To:
CC:ITA:B04
PLR-121384-20
Date:
March 29, 2021

   TY:                                                         --------------------------

Taxpayer = --------------------------------------------

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

Class of Products = -------------------------------------------------------------
--
Types of Products = -------------------------------------------------------------
------------------------------------------------------
Form of Product = ---------------------

Products = -----------

Specialists = -------------------------------------------------------------
--

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

This letter responds to your request for a ruling that gain from the sale of stock in
Taxpayer qualifies for the partial exclusion of gain under § 1202(a)(1) of the Internal
Revenue Code because Taxpayer is a qualified trade or business as defined in
§1202(e)(3) and Taxpayer 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).

                                                  FACTS

PLR-121384-20 2

Taxpayer, a domestic C corporation, is in the business of manufacturing Class of
Products as prescribed by third-party health care providers. Specialists employed by the
Taxpayer work on prescriptions referred by health care providers to evaluate, measure,
design, fabricate, manufacture, adjust, fit, and service Types of Products for the referred
individuals. Taxpayer’s revenue is generated by the sale of these products. The sales
generally consist of reimbursements from insurance companies, hospital systems, and
patients.

Taxpayer’s business operations include a corporate office, a fabrication facility, and -----
------------ lab locations.

Taxpayer sold all shares of its stock to another corporation on Date 1.

                                      LAW

Section 1202(a) provides 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(a)(4) provides that in the case of qualified small business stock acquired after the
date of the enactment of the Creating Small Business Act of 2010, § 1202(a)(1) shall be
applied by substituting “100 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)(1) provides that a corporation meets the active business requirement
for purposes of section 1202(c)(2) if at least 80 percent of the assets of the corporation
are used by the corporation in the active conduct of one or more qualified trades or
businesses.

Section 1202(e)(3) 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, athletics, financial services, brokerage services, consulting, or any other trade or
business where the principal asset of such trade or business is the reputation or skill of
one or more of its employees. Section 1202(e)(3) further provides that the term qualified
trade or business does not include businesses in which the principle activity involves
providing services in the fields of finance, insurance, banking, investing, leasing,
farming, mining, or running a hotel, motel, restaurant or similar businesses.
PLR-121384-20 3

                                   ANALYSIS

Taxpayer provides value to its customers primarily in the form of a tangible product such
as Class of Products. Taxpayer manufactures these products for individuals as
prescribed by health care providers who are not employed by Taxpayer. While
Taxpayer may directly interact with referred individuals and their respective diagnoses,
the interaction is incidental in ensuring these individuals receive a Form of Product as
provided by their prescription. Taxpayer’s business is more analogous to the business
of custom manufacturing than to offering services based on individual expertise.

Although the Products produced by Taxpayer are associated with the health industry,
we conclude that for the purposes of § 1202(e)(3), Taxpayer is not in the 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 and representations submitted, the Taxpayer is engaged in a
qualified trade or business under § 1202(e)(3).

                                    CAVEATS

Except as expressly provided herein, no opinion is expressed or implied 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.

A copy of this ruling must be attached to Taxpayer's federal tax returns for the tax year
affected. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of this letter ruling.

The ruling contained in this letter is based upon information and representations
submitted by Taxpayer, accompanied by a penalty of perjury statements executed by an
appropriate party. However, as part of an examination process, the Service may verify
the factual information, representations, and other data submitted.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

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.
PLR-121384-20 4

Pursuant to the Form 2848, Power of Attorney and Declaration of Representation, on
file, we are sending a copy of this letter to your authorized representatives.

This letter is being issued electronically in accordance with Rev. Proc. 2020-29, 2020-
21 I.R.B. 859. A paper copy will not be mailed to the taxpayer.

                                           Sincerely,




                                           Angella L. Warren
                                           Branch Chief, Branch 4
                                           (Income Tax & Accounting)

cc: