IRS Principal Business Activity Codes and QSBS

IRS Tax Code

What Types of Businesses Qualify as Qualified Small Businesses (QSBs)?

Qualified Small Business Stock (QSBS) is and the associated benefits are subject to more than a few restrictions and conditions. One of those being the actual trade of the business issuing the stock. Rather than clearly outlining the business that would qualify under Section 1202, the IRC outlines trades that would not be qualified

For those who find themselves with stock in a business that does not clearly fall onto the “qualified” side of these two categories, the question of “if” can be a tricky one. 

What are the IRS Principal Business Activity Codes?

A corporation must include their Principal Business Activity Code on Form 1120, Schedule K on lines 2a, 2b, and 2c.

The IRS Instructions for Form 1120 document (p. 27) defines Principal Business Activity Codes as such:

“This list of principal business activities and their associated codes is designed to classify an enterprise by the type of activity in which it is engaged to facilitate the administration of the Internal Revenue Code. These principal business activity codes are based on the North American Industry Classification System.”

If a company falls into more than one of the listed activities, they should choose the:

“activity the company derives the largest percentage of its “total receipts.” Total receipts is defined as the sum of gross receipts or sales plus all other income.”

Do any of the Principal Business Activity Codes Disqualify the Business from QSBS?

As very few rulings specific to QSBS and Section 1202 have been released, it is hard to say if the IRS looks specifically at Principal Business Activity Codes when determining whether or not a business may qualify. 

Regardless, it would be prudent for companies, if shuffling between two or more codes, to select a code that wouldn’t be a disqualifying activity. For example, section 1202 excludes farming from qualified trades there for the codes within the “Agriculture, Forestry, Fishing, and Hunting” category seem unlikely to qualify. 

In addition, the Principal Business Activity Codes differentiate between “Accommodation and Food Services” and the subsection for “Food and Beverage Stores” under the “Retail Trade” section. This brings up interesting questions for corporations wondering if they qualify as a restaurant.

The sections on “Real Estate and Rental and Leasing” and “Professional, Scientific, and Technical Services” seem dangerous due to the large amount of specific language disqualifying corporations within these trades from benefiting from the laws outlined in Section 1202.

How has the IRS Evaluated “Qualified Business Activities” in the Past for QSBS Purposes?

According to the Private Letter Ruling 201436001, the Internal Revenue service found that a pharmaceutical company providing products and services was a “qualified trade or business” despite the language in Section 1202 that names “fields related to health” and a trade that would not qualify.

There has not been clear guidance from the IRS on the definition of “qualified small business stock,” and while this ruling does provide taxpayers with some insight on the position of the IRS on what types of companies qualify under Section 1202, they are not bound by this ruling except to the individual who received it.

Looking for specific advice on QSBS? Contact us to learn more

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

About QSBS Expert

QSBS Expert was founded by a group of entrepreneurs, investors, accountants and lawyers who came together when trying to navigate a QSBS situation of their own. We quickly realized that the regulations left a lot of open questions and the publicly available information was confusing to sift through…so we thought that others may also benefit from having a “go to” resource for all things QSBS.