The Exclusion of Consulting Firms from QSBS Eligibility: Determining True “Consulting” Status and the Broader Implications

According to the Internal Revenue Code Section 1202 (I.R.C. §1202), investors can benefit from a substantial tax advantage through Qualified Small Business Stock (QSBS). Under this section, a complete exemption from federal capital gains taxes on profits gained from the sale of QSBS stock held for a minimum of five years is possible. However, it is important to note that various considerations come into play when determining whether a company’s stock qualifies for this exemption. 

One such qualification to consider is the qualified trade of the business. According to the regulations outlined in I.R.C. §1202, it is a requirement for corporations to establish themselves as a “qualified trade or business.” This classification encompasses all trades and businesses except those explicitly excluded under I.R.C. §1202(e)(3). Consulting is one such trade or business that falls under the exclusion. 

Consulting encompasses a wide range of services that involve providing advice and expertise to businesses. It typically spans various areas such as business strategy, marketing, operations, finance, and project management. However, despite its prevalence, the Internal Revenue Service (I.R.S.) has yet to provide an explicit definition of consulting under I.R.C. §1202, leaving room for interpretation. 

In a recent publication authored by Attorney Steven M. Hogan, a legal practitioner specializing in tax controversy matters, it has been expounded that three sources of administrative authority and caselaw may determine whether a business can be classified as consulting. These sources comprise Private Letter Rulings (P.L.R.s), case decisions, and the Treasury Regulations implementing I.R.C. §199A. Similarly, an article by Joseph Wiener, J.D., LL.M, and Stefan Gottschalk, CPA, J.D., LL.M., mentions the Code of Federal Regulations Section 1.448-1T (C.F.R § 1.448-1T) as another source for identifying consulting businesses. In the subsequent section, we shall delve into these four sources and examine them more closely.

Private Letter Rulings (P.L.R.s) Referencing “Consulting”

The Internal Revenue Service (I.R.S.) has established various tests to determine whether certain businesses qualify as a trade or business under I.R.C. §1202(e)(3)(A). In this regard, three P.L.R.s have been issued by the I.R.S. to clarify whether particular businesses are considered to be in “consulting”. It should be noted, however, that P.L.R.s are not considered as “precedent” under I.R.C. §6110(k)(3). Nonetheless, they can provide valuable insight into how the I.R.S. has approached similar issues.

The first of these three P.L.R.s is 201436001, which specifies that consulting companies and other enterprises whose primary asset is the reputation or expertise of their personnel are not qualified trades or businesses. This criterion is known as the “primary asset test.” 

Another P.L.R., 201717010, suggests that a company providing services can be a qualified trade or business if the services are performed by employees specifically trained for those tasks and those skills “are not useful to other employers.” The third P.L.R., 202144026, emphasizes that a company selling its employees’ expertise, such as legal or financial consulting services, is excluded from being considered a qualified trade or business. However, suppose a company sells a product or service that is not specifically prohibited under the statute. In that case, it is not excluded from being a qualified trade or business, even if aided by “individual expertise”.

The Owen Case

The ruling in Owen v. C.I.R. is of great significance regarding the principal asset test for corporations. This case is highly instructive as it provides an example of how a tribunal may view the issue of principal assets.

The essence of the case revolves around defining “qualified small business stock” for deferring recognition of gain under I.R.C. §1045, which refers to I.R.C. §1202 to define what “qualified small business stock” is. The I.R.S. argued that the company’s stock in question was not “qualified small business stock” since one of the company’s principal assets was the skill of its main employee/owner. However, the Tax Court disagreed and determined that the company’s principal asset was its training and organizational structure.

Significantly, the tax court’s decision demonstrates that even if a company’s success is attributable to the efforts of one or more key individuals, that is not evidence that the company’s principal asset is the reputation or expertise of those individuals under the Internal Revenue Code section 1202(e)(3)(A). This ruling is also a step towards recognizing the value of intangible assets such as organization, training, and expertise, which may not be easily quantified. This case is a valuable insight into the principal asset test for corporations and should be considered when evaluating a small business’s qualifications.

It is important to note that the I.R.S. has described the ruling as “dicta,” meaning it may not be considered a binding authority. Although the ruling in Owen is not binding authority on the terms of I.R.C. §1202(e)(3), it still provides a useful insight into the issue of principal assets. This case should be considered when evaluating the qualifications of a small business and serves as an example of how a tribunal may view the issue of principal assets.

Treasury Regulations Implementing I.R.C §199A and “Consulting”

In recent years, the I.R.C §199A has provided deductions for certain qualifying taxpayers. I.R.C. 199A(d)(2)(A) references I.R.C. 1202(e)(3)(A) as part of its description of which taxpayers are ineligible for the deduction. To further clarify this, Treas. Reg. §1.199A-5(b)(2) was promulgated to describe the types of services excluded from the deduction. For purposes of this regulation, “consulting” is defined as providing advice and counsel to clients as the primary economic transaction and does not include advice and counsel that is ancillary to a different product or service.

Furthermore, the regulation states that consulting does not include services other than advice and counsel, such as sales or providing training and educational courses. Ultimately, the regulation is instructive in interpreting I.R.C. § 1202(e)(3)(A) as applied to I.R.C. § 199A and should not be disregarded in an analysis of how I.R.C. §1202(e)(3)(A) may be applied to a taxpayer’s operations.

It is important to understand that the services in question must be the primary economic transaction to be excluded from the 199A deduction. As such, analyzing a taxpayer’s operations is necessary to determine whether the services provided are the primary economic transaction or are simply ancillary to another product or service. Furthermore, how the taxpayer is compensated for the services provided should also be considered.

The C.F.R § 1.448-1T

C.F.R. § 1.448-1T is a temporary regulation under Section 448 of the Internal Revenue Code (I.R.C.). It defines “consulting” for purposes of the I.R.C.’s limitation on the use of the cash method of accounting by personal service corporations (P.S.C.s).

The regulation states that “consulting means the provision of advice and counsel.” However, it also states that consulting does not include the performance of services other than advice and counsel, such as sales or brokerage services or economically similar services.

The determination of whether a particular service constitutes “consulting” is made on a case-by-case basis, taking into account all of the facts and circumstances of the business. One factor is how the taxpayer is compensated for the services provided. For example, if compensation is contingent upon the consummation of a transaction, the service is more likely to be considered “sales or brokerage” rather than “consulting.”

The regulation provides ten examples illustrating what does and does not constitute “the provision of advice and counsel.” These examples show that the line between consulting and other services can be blurry. For example, a company that studies a client’s needs and makes recommendations based on those needs may not be considered “engaged in consulting” if the client orders the equipment through the company and pays the company based on the number of orders made. In this case, the advice is considered ancillary to the delivered product. This is based on Example 6 of C.F.R. § 1.448-1T(e)(4)(iv)(B), wherein a company is in the business of analyzing a client’s data processing facility requirements and advising the client on the design and implementation of its data processing systems. The company is not considered to be in the “consulting” business, but rather in the “sales” sector, as its compensation came from the selling of equipment to clients. 

In general, a service will be considered consulting if it involves the provision of advice and counsel and if the compensation for the service is not contingent upon the consummation of a transaction. However, determining whether a particular service constitutes “consulting” is made on a case-by-case basis, considering all of the business’s facts and circumstances.

As has been established, the Internal Revenue Code Section 1202 (I.R.C. §1202) offers investors with a substantial tax advantage through Qualified Small Business Stock (QSBS). Navigating QSBS eligibility is complex, requiring careful evaluation on a case-by-case basis. Consulting firms face challenges due to their exclusion from qualified trades or businesses. The insights from P.L.R.s, the Owen case, and Treasury Regulations help clarify the definition of consulting firms. To ensure informed investment decisions and understand the tax implications, further analysis of a company’s businesses activities should be performed.



Gottschalk, J. W. (2020, April 1). What does ‘consulting’ mean for purposes of Sec. 1202? Retrieved from The Tax Adviser:

Legal Information Institute. (2023, July 22). 26 CFR § 1.199A-5 – Specified service trades or businesses and the trade or business of performing services as an employee. Retrieved from Cornell Law School:

Legal Information Institute. (2023, July 22). 26 CFR § 1.448-1T – Limitation on the use of the cash receipts and disbursements method of accounting (temporary). Retrieved from Cornell Law School: Information Institute. (2023, July 22). 26 U.S. Code § 1202 – Partial exclusion for gain from certain small business stock. Retrieved from Cornell Law School:

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

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