A medical-software company counts as a "qualified trade or business," so its stock can qualify for the section 1202 gain exclusion

Plain-English summary

Section 1202 lets a taxpayer exclude much of the gain (50, 75, or 100 percent depending on when the stock was bought) from selling "qualified small business stock," but only if the company runs a "qualified trade or business." Certain service fields are carved out and cannot qualify, including health, and so is any business whose principal asset is the reputation or skill of its employees. Here a C corporation builds software that helps medical providers and patients optimize treatment. The founder got shares as pay for consulting and later sold some, and asked the IRS whether the company is a qualified trade or business under section 1202(e)(3). The IRS ruled yes. It found the company does not practice medicine, has no patients, does not diagnose or recommend treatment, and instead sells a software tool that its healthcare customers use, so it is not performing services in the field of health and its value does not come primarily from individual expertise. The ruling is narrow: it decides only the qualified-trade-or-business question and does not decide whether the taxpayer meets section 1202's other requirements (such as the holding period).

Ruling snapshot

• Question: Is a company that sells software to medical providers a "qualified trade or business" under section 1202(e)(3), or is it disqualified as a health-services business?
• Outcome: Approved (company is a qualified trade or business; other section 1202 requirements not addressed)
• 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: 202144026 Third Party Communication: None
Release Date: 11/5/2021 Date of Communication: Not Applicable
Index Number: 1202.00-00
Person To Contact:
-------------- ---------------------------
------------------------------ ID No. -----------------
---------------------------- Telephone Number:
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Refer Reply To:
CC:ITA:B04
PLR-116074-20
Date:
August 10, 2021

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

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

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

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

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

Date 4 = -------------------------

Date 5 = ---------------------

Date 6 = ---------------------

Year 1 = -------

Year 2 = -------

Year 3 = -------

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

This letter responds to your request for a ruling that Company is a qualified trade or
business as defined in § 1202(e)(3) of the Internal Revenue Code (Code) for purposes
of qualifying for the exclusion of gain under § 1202(a).
PLR-116074-20 2

                                                 FACTS

Taxpayer has represented that the facts are as follows.

Taxpayer founded and incorporated Company, a C corporation, on Date 1 to develop
and commercialize software to assist medical providers in providing medical treatment
to individual patients. The goal of the software is to make medical treatment more
effective by optimizing the patient’s use of medical treatment or medication. For
example, --------------------------------------------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

--------------------------------------------------------------The software is a tool utilized by a
medical provider and patients. The medical provider makes all medical decisions.

Taxpayer represents that the Company does not practice medicine, has no patients,
and is not licensed to issue prescriptions. The taxpayer also represents that the
Company does not perform medical or laboratory tests and does not diagnose or
recommend patient treatment. The Company seeks potential customers --------------------
----------------------------------------------------------------------------------------------.

Taxpayer was a Consultant for Company from Year 1 to Year 2 during which time he
acquired shares of Company stock as compensation for services rendered. Taxpayer
received shares in connection with a consulting agreement with Company on Date 2.
Taxpayer received additional shares for services provided to Company on Date 3 and
Date 4. Taxpayer sold some of the shares in Company on Date 5 and Date 6. Taxpayer
previously sold shares of Company in Year 3 and reported the transaction on the Year 3
tax return.

                                                   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.
PLR-116074-20 3

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.

                                               ANALYSIS

Section 1202(e) excludes businesses from being a qualified trade or business if they
offer value to customers primarily in the form of certain specified services, or in the form
of individual expertise. Company is a technology company which develops software for
medical providers and patients to utilize as a tool in optimizing the patient’s treatment.
Company’s software allows patients to -----------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

--------------------------- The software and reports do not diagnose or recommend
treatment. These aspects of Company’s software illustrate that Company is not in the
business of providing health services but rather creating an asset to be utilized by their
customers in the healthcare industry.

Furthermore, Company is not a business that provides value to customers primarily in
the form of individual expertise. Company is not licensed to issue prescriptions and
perform medical tests. Company is not aware of and does not discuss the diagnoses or
treatment by healthcare providers. The healthcare providers make all medical decisions.
As such, it is the customers of Company who use their expertise to provide services in
the healthcare industry. Company’s sole function is to provide tools in the form of
software, applications, and reports to create value for healthcare providers and their
PLR-116074-20 4

patients. Company is not a business whose principal asset is the reputation or skill of
one or more employees.

Although the software and applications developed by Company are allied or associated
with the healthcare industry, we conclude that for the purposes of § 1202(e)(3),
Company is not in the trade or business of performing services in the field of health or
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 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. In particular, this ruling is limited to concluding that
Company is a qualified trade or business as defined in § 1202(e)(3) and reaches no
conclusion as to whether Taxpayer has satisfied the other requirements to qualify for
the exclusion of gain under § 1202(a).

A copy of this ruling must be attached to Taxpayer's federal tax returns for the tax years
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.

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.

Pursuant to the Form 2848, Power of Attorney and Declaration of Representation, on
file, we are sending a copy of this letter to Taxpayer's authorized representative.
PLR-116074-20 5

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,



                                 Ronald J. Goldstein
                                 Senior Technician Reviewer, Branch 4
                                 (Income Tax & Accounting)

cc: