IRS Halts PLRs on “Active Business” Requirement for QSBS

IRC Section 1202 offers little guidance as to what is meant by certain excluded trades or businesses outlined in Section 1202(e) – such as “health services”, “consulting”, “engineering”, etc.  As such, shareholders wondering whether the company they hold stock in is in a Qualified Trade have sought clarification from the IRS.  The IRS has issued such guidance through Private Letter Rulings (PLRs).  To date, the IRS has issued ~10 PLRs related to Qualified Trade considerations. However, the most recent ruling involving a Staffing Services company (PLR 202352009) may be the last such ruling for a while.  

According to Rev. Proc. 2024-3, published on January 2, 2024, the IRS has decided to temporarily stop issuing private letter rulings (PLRs) on whether a corporation meets the “active business” requirement for the QSBS tax incentive. This decision is part of the “no-rule list” that outlines the issues the IRS will not rule until it resolves the matter through publication of a revenue ruling, a revenue procedure, regulations, or otherwise. 

Opportunities and Challenges

Section 1202 offers a reduced capital gains tax rate on qualified small business stock (QSBS). However, corporations must meet a “qualified trade or business” requirement to qualify for this tax incentive. This requirement is complex and often ambiguous, making it difficult for taxpayers to determine whether their company or a company where they are shareholders meets the definition of QSB. Previously, taxpayers could seek guidance from the IRS to determine this matter.

However, with the IRS temporarily suspending “qualified trade or business” PLRs, corporations seeking the QSBS tax benefit face uncertainty. Without a ruling, they risk being challenged by the IRS later and denied the QSBS benefits. 

Nonetheless, when the IRS resumes issuing PLRs on the “active business” requirement for QSB eligibility, the implications could be far-reaching and multifaceted:

Potential for greater clarity: A published ruling (revenue ruling, procedure, or regulation) could provide much-needed clarification on the ambiguous “active business” definitions, setting a clearer precedent for future assessments. This could benefit both the IRS and taxpayers by streamlining the process and reducing litigation.

Increased scrutiny for PLR applications: The IRS may have a heightened awareness of the complexities surrounding “active business” after resolving the issue publicly. This could lead to a more stringent review of PLR applications and potentially fewer favorable rulings for borderline cases. Corporations seeking a PLR may need to demonstrate a stronger, more convincing case for compliance.

Shifting landscape for industry practices: Depending on the content of the published ruling, certain industry practices or business models that were previously considered “active” may no longer qualify. This could have significant implications for companies in those sectors, potentially forcing them to restructure their operations or seek alternative tax benefits.

Strategic timing for PLR requests: Companies may want to strategically time their PLR requests once the IRS resumes issuing them. Waiting until the published ruling establishes a more predictable landscape could be wise, especially for borderline cases. Conversely, companies with strong confidence in their “active business” status may seek a PLR sooner to establish certainty.

Evolving legal interpretations: Even with a published ruling, legal interpretations of the “active business” requirement may continue to evolve over time through court decisions and further IRS pronouncements. Corporations should remain vigilant and adapt their strategies as needed to stay compliant.

Overall, the eventual resumption of PLRs on QSB “active business” offers both opportunities and challenges for corporations. While greater clarity may eventually emerge, navigating the initial period of adjustment and adaptation will require careful planning and close attention to IRS pronouncements and legal developments.

Alternative Strategies for Shareholders and Corporations

In light of this change, shareholders and corporations should consider alternative strategies:

  • Focus on objectively meeting the active business criteria: The company should carefully review their activities and ensure they fall within the IRS’s definition of an active business, as outlined in existing regulations and case law.
  • Seek alternative guidance: Consult with tax advisors and QSBS specialists to help determine and manage QSBS eligibility.

This is where QSBS Expert steps in. Our team of specialists, deeply immersed in the nuances of the QSB criteria, can help you navigate this new landscape with confidence. We offer comprehensive services to:

  • Validate and substantiate your securities against the QSBS requirements. Through a meticulous analysis of your business activities, relevant regulations, and case law, we prepare detailed documentation to support your position for your QSB eligibility.
  • Prepare persuasive documentation. We meticulously document your compliance with the “active business” requirement, giving you tangible evidence to stand behind should the IRS come knocking.
  • Stay ahead of the curve. We closely monitor IRS pronouncements and industry developments, keeping you informed and equipped.

With the IRS closing the door on “qualified trade or business” PLRs for now, corporations and shareholders need a trusted partner to navigate the uncertainties and maximize their QSB prospects. QSBS Expert is here to guide you every step of the way, ensuring compliance, minimizing risk, and unlocking the full potential of this valuable tax benefit.

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