Direct-appointed insurance agency is a qualified Section 1202 business

Plain-English summary

A small insurance agency sold policies under direct appointments from insurers and also through wholesalers. At least 80 percent of its asset value supported the direct-appointment model. Those contracts required ongoing administrative work, including reporting claims, cooperating in investigations and settlements, and maintaining auditable records. The IRS concluded that this role went beyond acting as a mere intermediary and therefore was not excluded “brokerage services” under Section 1202(e)(3). Based on the taxpayer's representations, the business was a qualified trade or business while the taxpayer held the stock that was sold.

Ruling snapshot

• Question: Was the insurance agency a qualified trade or business for purposes of the Section 1202 small-business-stock exclusion?
• Outcome: Approved. The business was a qualified trade or business during the relevant holding period.
• Key authorities: IRC § 1202(e)(3); Walters v. Metro. Educational Enterprises, Inc.; Metro One Telecommunications, Inc. v. Commissioner

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202114002 Third Party Communication: None
Release Date: 4/9/2021 Date of Communication: Not Applicable
Index Number: 1202.00-00
Person To Contact:
----------------------------------- --------------------, ID No. ------------
-------------------------- Telephone Number:
---------------------------------------- --------------------
Refer Reply To:
CC:ITA:B05
PLR-111854-20
Date:
January 13, 2021

Legend

Taxpayer ------------------
Company = -------------------------------------
Predecessor = -------------------------------------
State ----------
a -----------
Date 1 ------------------
Date 2 ----------------------
Date 3 --------------------------
Month 1 ------------------
Year 1 -------

Dear -----------------------------------:

This ruling responds to your request dated Date 1. Specifically, you request a ruling
that Predecessor and Company (collectively “Business”) was engaged in a qualified
trade or business as defined in § 1202(e)(3) during the time Taxpayer held stock in
Company sold in Month 1.

FACTS

Predecessor was formed as a State state law corporation in Year 1. In exchange for
stock in Predecessor. Taxpayer and certain other shareholders contributed
approximately $ a of cash to Predecessor on Date 2. Predecessor converted into a
State state law limited liability company on Date 3 and became Company. The
conversion was treated as a tax-free reorganization within the meaning of section
368(a). Company continued to be taxed as a C corporation for federal income tax
PLR-111854-20 2

purposes. Business has never held aggregate gross assets (as defined under
sections 1202(d)(1) and (2)) exceeding $50 million.

Business works with its customers to obtain insurance, including property, casualty,
surety, worker’s compensation, employee benefits, personal and medical, and
professional practice insurance. As further explained below, Business conducts
business either as a representative or appointed agent of insurance companies or as an
agent appointed with a general wholesale agent.

Business operates under two general business models. First, it has contracts with
insurance companies (referred to as "direct appointments") to sell a product. Insurance
companies use this model to select and control who can sell the company's products.
For example, an insurance company may only want to work with certain agents capable
of a certain sales volume, thus excluding smaller agencies. Only independent agency
companies with direct agency appointment contracts have access to these insurance
products. Business generates revenue directly from the insurance company, often in
the form of commissions and other similar compensation arrangements paid either
directly from the insurance company or through withholding on a portion of a customer's
premium payments. Contracts with insurance companies require Business to perform a
number of administrative services. For example, Business must promptly report all
known incidents, claims, suits and notices of loss to the insurance company or its
designated claims adjuster and cooperate fully to facilitate any investigation,
adjustment, settlement and payment of any claim. It also must keep true and complete
records and accounts of all transactions and correspondence with the insureds at its
principal office, which records and accounts must be open to examination, inspection,
verification and audit by the insurance company upon reasonable notice. In some
cases, Business contracts with “program managers” or “managing general agents” who
represent insurance companies, rather than contracting directly with insurance
companies.

Second, Business also contracts with insurance wholesalers. Under this model,
Business has a contract with a wholesaler and not an insurance company, and these
wholesalers contract with multiple insurance companies. Business selects an
appropriate policy for a customer provided by a wholesaler. If the customer
accepts the policy, the wholesaler procures the policy from the insurance company.

Taxpayer represents that for the duration of the time Taxpayer held stock in Business
sold in Month 1, at least 80 percent (by value) of the assets of Business were used in
the conduct of business pursuant to the first model,

LAW

Section 1202(a)(1) provides that in the case of a taxpayer other than a corporation,
gross income does not include 50 percent of any gain from the sale or exchange of
qualified small business stock held for more than 5 years.
PLR-111854-20 3

Section 1202(a)(3) provides that in the case of qualified small business stock acquired
after February 17, 2009, and on or before September 26, 2010, the exclusion is 75
percent.

Section 1202(c)(2) provides that stock in a corporation is not treated as qualified small
business stock unless during substantially all of the taxpayer's holding period for such
stock, the corporation meets the active business requirements of subsection (e) and the
corporation is a C corporation.

Section 1202(e) provides that the active business requirements are met by a
corporation for any period if during such period at least 80 percent (by value) of the
assets of such corporation are used by such corporation in the active conduct of one or
more qualified trades or businesses, and such corporation is an eligible corporation.

Section 1202(e)(3)(A) provides that a qualified trade or business means any trade or
business other than a trade or business involving the performance of services in the
fields of health, law, engineering, architecture, accounting, actuarial science, performing
arts, consulting, athletics, financial services, brokerage services, or any trade or
business where the principal asset of such trade or business is the reputation or skill of
one or more of its employees.

Section 1202(e)(3)(B) further excludes from the definition of a qualified trade or
business any banking, insurance, financing, leasing, investing, or similar business.

ANALYSIS

Business has been referred to as an insurance agent or broker. Thus, a question arises
as to whether Business is engaged in “brokerage services,” which is not a qualified
trade or business for purposes of section 1202.

The term “brokerage services” is not defined in section 1202 or explained in the
legislative history. H.R. Rep. No. 111, 103d Cong., 1st Sess. 601 (1993). Words in a
statute generally are presumed to bear their ordinary, contemporary, common meaning.
Walters v. Metro. Educ. Enters., Inc., 519 U.S. 202, 207 (1997). To ascertain the plain
meaning of terms, courts have consulted the definitions of those terms in popular
dictionaries. Metro One Telecommunications, Inc. v. Commissioner, 704 F.3d 1057,
1061 (9th Cir. 2012) The dictionary definition of “broker” defines the term as “one who
acts as an intermediary: such as a : an agent who arranges marriages b : an agent who
negotiates contracts of purchase and sale (as of real estate, commodities, or
securities).” Additional, less common, meanings are “power broker” and “one who sells
or distributes something.” Broker, Merriam-Webster.com, https://www.merriam-
webster.com/dictionary/broker (last visited Jan. 7, 2021). With respect to business
performed pursuant to the first model described above, Business’s role is not that of a
mere intermediary. Contracts with insurance companies require Business to perform a
PLR-111854-20 4

number of administrative services beyond those that would be performed by a mere
intermediary facilitating a transaction between two parties. For example, Business must
promptly report all known incidents, claims, suits and notices of loss to the insurance
company or its designated claims adjuster and cooperate fully to facilitate any
investigation, adjustment, settlement and payment of any claim. It also must keep true
and complete records and accounts of all transactions and correspondence with the
insureds at its principal office, which records and accounts must be open to
examination, inspection, verification and audit by the insurance company upon
reasonable notice.

CONCLUSION

Based on Taxpayer’s representations, we conclude that Business was engaged in a
qualified trade or business as defined in § 1202(e)(3) during the time Taxpayer held
stock in Business sold in Month 1.

CAVEATS

Except as expressly provided in the immediately preceding paragraph, we do not
express or imply any opinion concerning the tax consequences of any aspect of any
transaction or item discussed or referenced in this letter under any provision of law,
including § 1202.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                   Sincerely,



                                   John M. Aramburu
                                   Senior Counsel, Branch 5
                                   (Income Tax & Accounting)

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