IRS Rules that Interim Staffing and Executive Search Services are QSBS Eligible

At a glance

• The main takeaway: In a Private Letter Ruling (PLR) issued October 3, 2023, the IRS ruled that shares issued by an interim staffing and executive search company satisfied the requirements to be eligible for qualified small business stock (QSBS) gain exclusion.
• Impact on your business: Service-providing companies may be eligible for QSBS gain exclusion if the provided services are based on client needs, rather than professional judgement.
• Next steps: Aprio’s Transaction Advisory Team is here to help determine your company’s QSBS eligibility and maintain compliance with complex tax laws and regulations. 

Background

The Internal Revenue Code (IRC) §1202, known as the Small Business Stock Gains Exclusion, outlines tax benefits to investors in new ventures, small businesses, and specialized small business investment companies. Under this Section, capital gains from certain small business stocks are excluded from federal tax. Specifically, non-corporate investors may exclude up to 100% of the gain they realize from the disposition of QSBS issued after August 10, 1993, and held for more than five years.

However, not all small business stock qualifies. There are four main requirements that must be satisfied before gain on the sale of stock is potentially eligible for the exclusion under §1202.

1. The stock must be shares in a domestic C Corporation and have been acquired at original issuance.
2. The issuing corporation must be a qualified small business, meaning, at a high-level, that the aggregate gross assets of such corporation do not exceed $50 million.
3. At least 80% of a company’s assets must be actively used in aqualified trade or business.
4. The stock must be held for more than five years in order for the amount of any gain realized from the sale or exchange of such stock to be eligible for exclusion.

What is a qualified trade or business?

In general, qualified trade or business excludes services related to health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, finance, banking, insurance, leasing, investing, or brokerage. Companies that rely on an employee or owner’s reputation or produce products for which percentage depletion can be claimed are also excluded.

Regarding cases where these rules and standards are unclear, taxpayers have faced significant uncertainty in applying QSBS gain exclusion rules.

A Unique Case

The PLR issued in October addressed the qualification of a company that performs temporary staffing services. While consulting services are typically excluded from qualification under §1202, the IRS ruled that the Company was eligible for QSBS gain exclusion as a qualified trade.

The Company involved in this case provided two main categories of staffing services that included (i) interim staffing and (ii) executive searching. The interim staffing services consisted of matching highly trained professionals with clients’ self-identified needs as temporary or interim employees for particular positions or projects.

For the interim staffing services, the Company billed clients at an agreed upon rate for the time professionals spent on projects, as well as time billed for engagement oversight and project communication services provided by the Company’s employees. Once the professionals were placed with clients, they were legally taken on as the clients’ employees. The clients were responsible for the supervision of assigned professionals, as well as the provision of their resources, workstations, and tools. For the executive searching services, the clients engaged the Company for a fee equal to a percentage of the executive’s first year of annual compensation.

The IRS Ruling

While these facts might suggest disqualification under IRC §1202, the IRS analyzed the underlying legalities between the Company and its clients to define “consulting” in this case.

Given that (i) the clients supervised and directed the placed professionals and were responsible for the professionals performance, and (ii) the business was not engaged in a trade involving the performance of consulting services where the principal asset of the business was the reputation or skill of the employees, the IRS determined that these activities did not constitute as traditional “consulting” services.

Therefore, IRS ruled that the Company was engaged in a qualified trade or business as defined in §1202(e)(3).

The Bottom Line

The IRS determined that the staffing services provided by the Company were facilitated based on client needs, rather than professional judgement.

Navigating the nuances of the tax landscape in instances such as this can be challenging and complex. Schedule a meeting with Aprio’s Transaction Advisory Team to qualify your company’s business and maximize tax benefits under the IRC.