IRS Blesses Small Business Stock Treatment for Insurance Brokerages

When is a brokerage not a brokerage?

According to a recent Private Letter Ruling (PLR) released by the IRS, the answer might surprise you. In PLR 202114002, the IRS held that an insurance brokerage firm was not in the field of “brokerage services” and that it therefore qualified as a small business for purposes of the Code Section 1202 exemption.

For those not familiar with Section 1202 of the Internal Revenue Code (the Code), Section 1202 exempts from taxable income gains from the sale of certain small business stock.

To qualify, small business stock must be issued by a C-corporation after August 10, 1993 and have been issued by a company with less than $50 million in assets, at least 80 percent which are used to conduct a qualified business.

Section 1202 defines a qualified trade or business through exclusion rather than a traditional statutory definition. A “qualified trade or business” means any business outside a specific list of enumerated industries. Included in this statutory list are “brokerage services firms.” One could be forgiven for assuming, based solely on linguistic equivalence, that an insurance brokerage would be a “brokerage service firm.” Not so.

In PLR 202114002, the IRS determined that an insurance brokerage firm was not operating in the “brokerage services” field for purposes of Section 1202 and could therefore qualify for the Section 1202 exemption. The decision made clear that the IRSs definition of “brokerage services” that were prohibited from utilizing Section 1202 was unexpectedly quite narrow. In the PLR, the IRS concluded that “brokerage services” firms included only businesses that operated as “mere intermediar[ies] facilitating transaction[s] between two parties.” The IRS held that the insurance brokerage firm involved in the PLR was able to distinguish itself from this classification by also performing “administrative services” such as reporting incidents, claims and suits, keeping records of transactions and correspondence, and tracking the examination, inspection, verification and audit of accounts.

With this narrowed interpretation of “brokerage services” that could not benefit from Section 1202, more insurance brokerage firms may explore taking advantage of Section 1202 benefits if they otherwise qualify. It is well known among tax practitioners, however, that only the party who requested the PLR may rely on it. If other insurance brokerages want to assess whether the analysis in the PLR may be something to take advantage of, they should engage counsel to analyze their situation and provide an opinion or other appropriate documentation to support the client’s return position. In appropriate situations, however, an insurance broker could request its own PLR from the IRS.

Should companies outside the “insurance brokerage” industry extrapolate this PLR to their own business? Since the PLR is only binding on the actual taxpayer involved, and since PLRs are not themselves recognized “authority” on which to base a tax return position (and thus avoid certain penalties), it may be premature to become too aggressive. Yet, the IRS has lit the candle and there are fewer shadows on the road to taking advantage of Section 1202 than there were previously. As is the case with many tax issues, seeking professional help is the best path forward.

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