Letter ruling provides clarity on Sec. 1202 definition of brokerage services.

• Author: Adams, Evan

Sec. 1202 allows shareholders to exclude gain from the sale of qualified small business stock (QSBS) from income. Many requirements at both the shareholder and corporate level must be satisfied for stock to qualify as QSBS. Of these requirements, perhaps the most difficult to apply is the active business requirement, which mandates that at least 80% (by value) of the assets of the corporation must be used in the active conduct of one or more qualified trades or businesses. A qualified trade or business is defined through exclusion, with a laundry list of categories of businesses that may not be treated as qualified trades or businesses. Among these excluded businesses is any trade or business involving the performance of services in the field of brokerage services (Sec. 1202(e)(3)(A)). There is no definition of "brokerage services" in Sec. 1202 or its regulations.

Letter Ruling 202114002 involves a corporation that assists clients in obtaining various types of insurance policies. In the business line that is the subject of the ruling, the corporation enters into contracts with insurance companies to sell policies to customers in exchange for commissions from the insurance companies. These contracts require the corporation to perform certain administrative services, including reporting incidents, claims, suits, and notices of loss to the insurance company and cooperating to facilitate any investigation, adjustment, settlement, and payment of any claim. The corporation is also required to keep records of all transactions and correspondence with the insureds and to make those records available to the insurance companies for examination, inspection, verification, and audit.

In the ruling, the IRS noted that there is no definition of "brokerage services" in Sec. 1202 and no explanation in the legislative history. Citing case law holding that "[w]ords in a statute generally are presumed to bear their ordinary, contemporary, common meaning," the IRS turned to dictionary definitions of the term "broker": "one who acts as an intermediary: such as... an agent who negotiates contracts of purchase and sale (as of real estate, commodities, or securities)." In applying this definition, the IRS concluded that the corporation was not a mere intermediary because the corporation performed administrative services under its contracts with the insurance companies (reporting claims/incidents and keeping records of transactions and correspondence). Accordingly...