How Does the IRS Define “Consulting” Services From a QSBS Perspective?

Consulting Industry

One of the many areas of 26 U.S.C.A. § 1202 that is creating the questions from corporations looking to determine if their company qualifies for the tax exemption falls under Section 1202(e)(3)(A); which broadly states how the IRS defines excluded trades or businesses for the qualification of Section 1202. Before analyzing the qualifications Section 1202(e)(3)(A) defines Qualified trades or businesses in the negative:

“[E]xcluding any 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 1 or more of its employees.”

26 U.S.C.A § 1202(E)(3)(A).

Regulations That Clarify the Broad Language of Section 1202(e)(3)(A)

While guidance in Section 1202 is limited, other regulations help clarify how the IRS likely views these trades or businesses in a QSBS/Section 1202 perspective. These regulations are:

  • Temporary regulations under 26 U.S.C.A. § 448(d)(2) provides definitions for certain fields.
  • A number of cases and IRS rulings (Private Letter Rulings) under Section 448and Section 1202 provide additional guidance regarding what constitutes certain trades or business. These cases and private letter rulings can be found at the bottom of the article.
  • Code of Federal Regulation § 1.199A-5 is used to define businesses that qualify under the qualified business income deduction (QBID); however, the IRS looks at these definitions to expand on the broad language found under § 1202(e)(3).

Consulting Services Defined Under the Code of Federal Regulations

Under § 1.199A-5: Specified service trades or businesses and the trade or business of performing services as an employee, the term definition of performance of services in the Consulting field as:  

“[T]he provision of professional advice and counsel to clients to assist the client in achieving goals and solving problems . . . includ[ing] providing advice and counsel regarding advocacy with the intention of influencing decisions made by a government or governmental agency and all attempts to influence legislators and other government officials on behalf of a client by lobbyists and other similar professionals performing services in their capacity as such.”

Reg. §1.199A-5(b)(2)(vii)

However, there are exceptions that this provision has left out of discussion; such as, the performance of services that are not directly related to consulting services. Some examples include: 

  • Service of Sales or economically similar services, or 
  • Provision of training and educational courses. See Reg. §1.199A-5(b)(2)(vii).

Additionally, these services will be looked at more closely through the facts of the situation and in what way the taxpayer has been compensated for such services. 

The reason the IRS will analyze the taxpayers compensation of services is because,

“[P]erformance of consulting services embedded in, or ancillary to, the sale of goods or performance of services on behalf of a trade or business that is otherwise not an SSTB (such as typical services provided by a building contractor), if there is no separate payment for the consulting services.”

Reg. §1.199A-5(b)(2)(vii).

A commenter brought up an argument that produced an ambiguous situation; such as, a sales transaction (sale of a TV) may come in connection with consulting services (mounting to the wall). See REG-107892-18

Private Letter Rulings Providing Guidance on What Activities are Considered the Performance of Services in the Field of Consulting

The first, PLR 200606020, delivers a ruling that states a company that provides opinions on valuations and appraisals is not considered a qualified personal service corporation (QPSC) under § 448 of the Internal Revenue Code. More Specifically, a discussion on whether the company is not considered in the Consulting industry as defined in Reg. §1.199A-5(b)(2)(vii)

“The taxpayer is engaged in the performance of brokerage or sales services. Relevant to this determination is the fact that the compensation of the taxpayer for its services is contingent upon the consummation of the transaction the services were intended to effect (that is, the purchase of insurance products by its clients)….While Taxpayer does provide a service (that is, ascertaining value), Taxpayer is not considered to be engaged in the performance of services in the field of consulting.”

PLR 200606020 at 3.

The second, PLR 9602013, explains that a company that provides services of: (i)architecture, (ii) interior design, (iii) graphic design, (iv) lighting design, (v) marketing consulting, and (vi) merchandising services to retail business (department stores, restaurants, etc) is considered to fall under the “Consulting” services is described in Code section 448(d)(2)(A)

“[A]rchitecture, is set forth in the statute and has been defined as “the art or practice of designing and building structures.” Webster’s Third New International Dictionary (Unabridged 1986). That definition fits your description of the architectural services provided by the companies and to be performed by the corporation. As to the remaining services described in your ruling request, interior design, graphic design, lighting design, marketing consulting and merchandising services, we conclude that such services fall within the regulations’ definition of consulting insofar as they involve providing advice and counsel to clients, but do not resemble sales, brokerage, or economically similar services.”

I.R.S. P.L.R. 9602013 (Jan. 12, 1996)

The third, PLR 8913012, explains that a company that provides educational training courses and education material to computer users is not considered a “Consulting” service under section 448(d)(2)(A).

“[T]he taxpayer is not considered to be engaged in the performance of services in the field of consulting. X does provide a service i.e. providing educational training courses and educational material to computer users. Therefore, X is not engaged in the performance of services in the field of consulting.”

I.R.S. P.L.R. 8913012 (Mar. 31, 1989)

Lastly, PLR 8902005, ruled that a company providing lobbying services is not considered to fall under “Consulting” services in  section 448(d)(2)(A). The company is not paid for their advice given to the client; rather, there is a fee for the company trying to make a result happen. The ruling stated:

“[The Company is] not considered to be engaged in the performance of services in the field of consulting [because it] does not render advice and counsel to its clients since….[the company] does not examine its clients’ businesses to determine their needs and make recommendations intended to meet its clients’ needs. [The company’s] sole activity is to influence the outcome of legislation or administrative actions in accordance with its clients’ wishes.”

I.R.S. P.L.R. 8902005 (Jan. 13, 1989)

This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.