Can I ask the IRS if my company qualifies as a Qualified Small Business?
Taxpayers can seek guidance from the IRS to determine whether their company or a company in which they are a shareholder meets the definition of a Qualified Small Business (QSB). This would involve requesting a private letter ruling from the IRS. Below we will explore what a private letter ruling entails and walk you through an example to help you understand the factors that come into play.
What is a private letter ruling from the IRS?
Any taxpayer can contact the IRS for clarity on a question related to their specific tax situation and receive a private letter ruling (PLR). A PLR is a written decision by the IRS based on the facts as stated by the taxpayer. Because a PLR is provided in response to one taxpayer’s unique circumstances, the ruling cannot be used as a precedent by other taxpayers.
What types of rulings has the IRS issued related to QSBS?
Most QSBS rulings issued by the IRS address whether a particular company’s activities meet the definition of a “qualified trade or business.” This definition is stated in Section 1202(e)(3) of the Internal Revenue Code.
To help taxpayers understand the legal thought process, the IRS publicly releases edited versions of private letter rulings. Here is one released in April 2021, with identifying details omitted by the IRS: Private Letter Ruling Example. You’ll see that the letter:
- Opens by recounting the facts about the case including the history of the company’s tax status, shareholder investments, business models, and other notable details.
- Cites any relevant tax laws and analyzes how this applies to the taxpayer’s particular situation.
- Concludes with a succinct answer to the taxpayer’s question, in this case: “was the company a qualified trade or business at the time that the taxpayer held stock in the company?”
- Reminds the taxpayer that this ruling applies only to the specific situation in question and was determined based on facts provided by the taxpayer—if the facts were misrepresented in any way, the ruling may not apply, of course.
Coinbase: A quick study
Here’s an example of a specific case: the company Coinbase launched an IPO on April 14, 2021, and an interested party reached out to QSBS Expert for advice on determining if Coinbase shares are eligible for QSBS exemption. Please note that the below is a brief initial analysis based on publicly available information and is not based on any work with Coinbase or its shareholders.
Based on information from publicly available sources, here are some key considerations we noted for Coinbase:
- Business activities: The definition of a “qualified trade or business” excludes certain business activities such as financial services, brokerage services, and banking, per Section 1202(e)(3).
One financial technology PLR recently released by the IRS indicates that companies may not fall under the category of “brokerage services” if they perform additional administrative services. As Coinbase’s S-1 tells us that their revenue comes from “transaction fees on our platform in connection with the purchase, sale, and trading of crypto assets by our customers,” the question to resolve is to what extent the company’s activities may or may not be considered “brokerage services” for purposes of QSBS, given the additional administrative services performed.
Regarding other elements of the Qualified Small Business criteria, we note:
- Gross Assets: The Company’s aggregate gross assets cannot have exceeded $50mm at the time the securities were issued, per Section 1202(d). Coinbase’s Series C round, closed in January 2015, was for $75mm, so any securities that could potentially qualify as QSBS would likely need to have been issued before the Series C round.
- Business structure: The stock needs to have been issued by a domestic C Corporation, per Section 1202(e)(4). Coinbase’s S-1 (securities registration) form says that they were initially incorporated in May 2012 as a Delaware corporation, but since then they have established a global holding company, completed a corporate reorganization, and gained subsidiaries incorporated in the UK and in New York. The Company’s restructuring activities and subsidiaries need to be taken into account in evaluating QSBS status.
For a formal analysis of Coinbase, we would also want to know if the Company has pursued a PLR of their own or has otherwise performed a QSB analysis. This example gives you an idea of the considerations that need to be taken into account to determine QSBS status.
If you are an early shareholder of Coinbase, contact us today, and we will be happy to further assist you.
How do you request a private letter ruling from the IRS?
If you are interested in obtaining a PLR, you can consult the Revenue Procedure that is published each calendar year to read about the steps involved and the applicable fees. See the most recent publication here: Revenue Procedure 2021-2.
To learn more about QSBS related Private Letter Rulings, you will soon be able to visit the QSBS Case Law section of our website, which will include private letter rulings and other similar regulatory updates.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.