In a private letter ruling, PLR 201436001, the IRS ruled that a corporation (Company) that provides products and services to the pharmaceutical industry was engaged in a qualified trade or business for purposes of Section 1202.

As such, a shareholder (Taxpayer) of Company could exclude 50% of the gain that Taxpayer incurred on the sale of Company stock under Section 1202. The gain exclusion under Section 1202 is 75% for stock acquired between Feb. 18, 2009, and Sept. 27, 2010, and 100% for stock acquired between Sept. 28, 2010, and Dec. 31, 2013.

Company provides products and services primarily in connection with the pharmaceutical industry, specifically working with its clients to commercialize experimental drugs. Those activities include research on drug formulation effectiveness, precommercial testing procedures and manufacturing of the drugs.  During the year in question, Taxpayer disposed of certain stock in Company at a taxable gain.

In general, Section 1202(a) provides that gross income does not include 50% of any gain from the sale or exchange of qualified small business stock held for more than five years. Generally, to qualify as small business stock, at least 80% of the assets of a corporation must be used in the active conduct of one or more qualified trades or businesses, known as an active business requirement. For purposes of the active business requirement, the performance of services where the principal asset is the reputation or skill of employees is not a qualified trade or business.

The IRS ruled that Company used its manufacturing assets and intellectual property, rather than individual expertise, to create value for customers. As such, even though Company provides services, the services are a qualified trade or business for purposes of the active business requirement, and Company’s stock was qualified small business stock under Section 1202.