One of the many areas of 26 U.S.C.A. § 1202 that is creating the most 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 448 and 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).
Health 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 field of health as:
“the provision of medical services by individuals such as physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and other similar healthcare professionals performing services in their capacity as such.”Reg. §1.199A-5(b)(2)(ii).
However, there are exceptions that this provision has left out of discussion; such as, the performance of services that are not directly related to medical services but may be related to the health of patients. Some examples include:
- Operating a health club or health spa that provides physical exercise or conditioning to customers,
- Payment processing, or
- The research, testing, and manufacture and/or sales of pharmaceuticals or medical devices. See Reg. §1.199A-5(b)(2)(ii)
Private Letter Rulings Providing Guidance on What Activities are Considered the Performance of Services in the Field of Health
The first, PLR 201436001, delivers a ruling that states research, manufacturing, and even testing of pharmaceuticals are not in the business of serving patients. Rather,
“[The] Company’s activities involve the deployment of specific manufacturing assets and intellectual property assets to create value for customers”PLR 201436001 at 3
The second, PLR 202125004, explains that a company that manufactures products that are prescribed by health providers are not performing services in the field of health under Section 1202(e)(3)(A) because the Company was merely providing products to a third party and not directly to patients.
“Taxpayer provides value to its customers primarily in the form of a tangible product such as Class of Products”PLR 202125004 at 3.
Lastly, PLR 201717010, ruled that using a patented technology that would test a healthcare provider’s patients and then provide the healthcare provider with a report was not performance of services in the field of health under Section 1202(e)(3)(A). The Company never recommended treatment nor diagnosed the patients directly, the ruling stated:
“Company’s sole function is to provide healthcare providers with a copy of its laboratory report.”PLR 201717010 at 3.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.