Data migration company was not a consulting business for qualified small business stock purposes

Plain-English summary

A shareholder asked whether a company that provides data migration and management services operated a qualified trade or business for the section 1202 exclusion for gain on qualified small business stock. The company's teams assessed customer needs, designed migration roadmaps, implemented the data migration, and provided post-migration technical services. Although employees gave some advice and counsel, that work was embedded in and ancillary to implementation, and the company did not bill for it separately. The IRS ruled that the company was not engaged in the excluded field of consulting and therefore was engaged in a qualified trade or business under section 1202(e)(3). The ruling did not address whether the shareholder met the other requirements for the gain exclusion and was conditioned on the representation that the company's S corporation election was invalid.

Ruling snapshot

• Question: Did the data migration and management company operate a qualified trade or business rather than a consulting business under section 1202(e)(3)?
• Outcome: Approved
• Key authorities: IRC §§ 1202(a), (c), and (e)

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                              Washington, DC 20224

 Number: 202342013                                            Third Party Communication: None
 Release Date: 10/20/2023                                     Date of Communication: Not Applicable
 Index Number: 1202.00-00
                                                              Person To Contact:
 ----------------------                                       ----------------------, ID No. -----------------
 ----------------------------                                 Telephone Number:
 -----------------------------                                --------------------
                                                              Refer Reply To:
                                                              CC:ITA:08
                                                              PLR-120748-22
                                                              Date:
                                                              July 24, 2023

TY: -------

Legend:

Taxpayer = ------------------------------------------------
Company = ------------------------
Date 1 = -----------------------
Date 2 = ------------------
Year 1 = -------
A = --

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

This is in response to a letter sent on your behalf by your representatives dated -----------
------------. In the letter, your representatives requested a ruling on your behalf
that Company is engaged in a qualified trade or business as defined in section
1202(e)(3) of the Internal Revenue Code (Code) for purposes of qualifying for the
exclusion of gain under section 1202(a)(1) and is not engaged in a trade or business
involving the performance of services in the field of consulting within the meaning of
section 1202(e)(3)(A).

FACTS

Company was formed in Year 1 and elected classification as an association to be taxed
as a C corporation. It is owned by A individual shareholders, one of whom is Taxpayer.
On Date 1, Company elected to be classified as an S corporation but Company had
more than one class of stock in violation of section 1.361-1(l)1 of the Regulations.
Thus, Taxpayer represents that its S corporation election was immediately invalid.
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Company offers data migration and management services to businesses. It does not
sell software or technical equipment as part of the services it provides. To understand
its customers' needs, Company creates a transformation assessment plan. Its service
delivery teams determine an optimized cloud and data transformation roadmap based
on assessment outcomes. Company team members will integrate into the customer's
team often on a full-time basis to orchestrate and troubleshoot the data migration and
work to implement the data migration, as well as provide limited advice and counsel
when working with a customer’s team. Company also provides post-migration managed
technical services, which include monitoring and resolving incidents.

The invoices provided to Company's clients for the services it performs represent billing
for implementation services and embedded advice. Company does not separately bill
for advice and counsel. Taxpayer represents that more than 80% of Company's assets
are used in its data migration and management business.

Taxpayer sold all of its shares in Company on Date 2.

Law and Analysis

Section 1202(a)(1) of the Code provides that in the case of a taxpayer other than a
corporation, 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 February 17, 2009, and on or before September 27, 2010, the exclusion is 75
percent.

Section 1202(a)(4) provides that in the case of qualified small business stock acquired
after September 27, 2010, the exclusion is 100 percent.

Section 1202(c)(1) provides that the term ‘qualified small business stock’ means any
stock in a C corporation which is originally issued after the date of enactment in 1993 if
as of the date of issuance, such corporation is a qualified small business and except as
otherwise provided, such stock is acquired by the shareholder at its original issue in
exchange for money or other property (not including stock) or as compensation for
services.

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 subsection (e) and the
corporation is a C corporation.

Section 1202(e)(1) provides that the active business requirements are met by a
corporation for any period if during such period at least 80 percent (by value) of the
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assets of such corporation are used by such corporation in the active conduct of one or
more qualified trades or businesses, and such corporation is an eligible corporation.

Section 1202(e)(3) provides that a qualified trade or business means any trade or
business other than (A) 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 employee; (B) any banking, insurance, financing, leasing, investing,
or similar business; (C) any farming business (including the business of raising or
harvesting trees); (D) 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,
and (E) any business of operating a hotel, motel, restaurant, or similar business.

Company’s employees provide advice and counsel as part of the process of determining
a client’s data management needs but the advice and counsel is ancillary to and supports
the sale of the implementation work Company’s employees perform. Company does not
separately bill for advice and counsel, but only for its final product of implementing data
management solutions. Therefore, Company does not engage a trade or business
involving the performance of services in the field of consulting.

CONCLUSION

We conclude that for the purposes of section 1202(e)(3), Company is engaged in a
qualified trade or business as defined in section 1202(e)(3) and is not engaged in a
trade or business involving the performance of services in the field of consulting within
the meaning of section 1202(e)(3)(A).

Except as expressly provided herein, no opinion is expressed or implied concerning the
federal income tax consequences of any aspect of any transaction or item discussed or
referenced in this ruling including whether the other statutory and regulatory
prerequisites for exclusion of capital gain under section 1202 were satisfied.
Specifically, no opinion is expressed or implied concerning whether the Company made
an invalid S corporation election on Date 1. However, this ruling is conditioned upon
Taxpayer’s representation that the S corporation election on Date 1 was invalid.

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

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
PLR-120748-22                               4

attaching a statement to their return that provides the date and control number of the
letter ruling.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. 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.

                                         Sincerely,

                                         Erika C. Reigle
                                         Senior Technician Reviewer, Branch 8
                                         (Income Tax and Accounting)

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