Why Fintech and Insurtech Companies Should Look Into Qualified Small Business Stocks
Buying qualified small business stock (QSBS) makes for a key part of a robust investment strategy because it facilitates a capital gains tax exclusion. The concept is simple; if you invest in a qualified small business, you may exclude from your taxable income some or all of your associated gains. But in practice, many investors struggle to identify these sorts of small businesses which meet IRS requirements.
In Section 1202(e)(3)(A) of the Internal Revenue Code, a qualified trade or business is defined as a business engaged in activities other than health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting. athletics financial services, or brokerage services. This prohibition obviously eliminates many small businesses from investment consideration. However, a recent private letter ruling provides some optimistic guidance regarding shares in companies engaged in two specific industries: financial technology (Fintech) and insurance technology (Insurtech).
Private Letter Ruling (PLR) 202114002, released on April 9, 2021, notes that “brokerage services” is never defined in section 1202 and is not explained in the legislative history. In the absence of specific legislative guidance, the common definition of a broker or brokerage applies. A broker serves as an intermediary or an agent who negotiates purchase contracts.
This PLR describes a business working with customers to obtain all types of insurance. Its revenue comes directly from insurance companies or from customer premium payments. Contract terms with those insurance companies require the business to perform administrative services, including claims investigation, adjustment, settlement, recordkeeping, and reporting. Because this business performs “a number of administrative services beyond those that would be performed by a mere intermediary facilitating a transaction between two parties,” the ruling states that “yes,” the business would in fact constitute a qualified trade or business.
What Does This Ruling Mean for Fintech and Insurtech Companies
This ruling shows that Fintechs and Insurtechs who assist in broker transactions aren’t necessarily performing brokerage services if they are using added tools, technologies, or administrative services. The IRS differentiates a “mere intermediary” from a business whose activities push them to the level of a qualified business or trade.
Private letter rulings can’t serve as official precedent, as they directly apply only to the taxpayer who requested the ruling. But this PLR is a signpost to investors, showing that the IRS differentiates between a bank or insurance company and businesses that serve as a link between customers and those banks or insurance companies. As you build your QSBS strategy, consider Fintech and Insurtech shares as viable options for investment. If you need specific guidance with QSBS, please contact us.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.