Does My Company Qualify for QSBS? Understanding the Qualified Trade or Business Requirement
Does every startup qualify for Qualified Small Business Stock (QSBS) treatment? No. One of the most important requirements under Code Section 1202 is that the corporation must be engaged in a qualified trade or business. While many technology, software, manufacturing, and product-focused companies may qualify, certain service-based businesses are expressly excluded.
What Is a Qualified Trade or Business?
Code Section 1202 excludes certain specified service businesses from QSBS treatment. As a result, qualification often depends on the nature of a company's activities rather than its legal structure or marketing materials.
Businesses Commonly Excluded from QSBS Treatment
Professional Service Businesses
• Law
• Accounting
• Health
• Consulting
Financial Businesses
• Banking
• Insurance
• Financial services
• Brokerage services
Other Excluded Businesses
• Athletics
• Farming
• Hospitality businesses
• Businesses whose principal asset is the reputation or skill of employees or owners
Does a SaaS Company Qualify for QSBS?
Many software and technology companies may qualify for QSBS, but qualification depends on their actual activities. A business that licenses proprietary software may present a stronger QSBS profile than a company that primarily provides customized consulting services. The IRS generally focuses on whether customers are purchasing a scalable product or platform rather than the personal expertise of specific individuals.
IRS Guidance on Qualified Trade or Business Status
Although Code Section 1202(e)(3) provides the statutory framework, several IRS rulings provide valuable insight into how the qualified trade or business requirement is applied in practice.
In PLR 201436001, the IRS considered a pharmaceutical research, testing, and manufacturing company. Despite operating in a healthcare-related industry, the IRS concluded that the company was not engaged in the performance of services in the field of health because its value was derived primarily from research capabilities, manufacturing assets, intellectual property, and operational infrastructure rather than the personal services of medical professionals.
In PLR 202319013, the IRS evaluated a software-oriented business that relied heavily on proprietary methodologies, processes, and intellectual property. Although employees possessed substantial expertise, the IRS concluded that the company's principal asset was not the reputation or skill of its employees because the business relied on scalable systems, proprietary know-how, and repeatable processes that could be taught to newly hired personnel.
The IRS has also issued favorable guidance involving healthcare technology businesses that develop software used by medical professionals. In those situations, the IRS has emphasized the distinction between providing healthcare services and providing technology used by healthcare providers. This distinction may be particularly important for AI, digital health, and software-enabled businesses.
When Is a Company's Principal Asset the Reputation or Skill of Its Founders?
One of the most difficult exclusions applies when the principal asset of the company is the reputation or skill of one or more employees or owners.
More likely to be problematic:
• Consulting firms
• Investment advisory businesses
• Influencer businesses
• Agencies
Potentially more favorable:
• Software companies
• Product businesses
• Companies with proprietary intellectual property
• Businesses with scalable systems and recurring revenue
Illustrative Examples
Example 1: SaaS Company
A company licenses proprietary software on a subscription basis and generates recurring revenue from thousands of customers. This fact pattern generally presents a stronger QSBS profile.
Example 2: Consulting Firm
A business derives most of its revenue from founder expertise and hourly consulting engagements. This fact pattern may present a greater risk of falling within an excluded service business category.
Example 3: Medical Device Company
A corporation develops and manufactures medical technology products. Despite operating in the healthcare industry, the company may qualify if it is primarily engaged in product development and manufacturing rather than the provision of healthcare services.
How Companies Can Improve Their QSBS Position
Companies seeking QSBS eligibility often focus on building enterprise value independent of any single individual. Factors supporting qualification may include:
• Proprietary technology
• Institutional branding
• Recurring revenue
• Transferable customer relationships
• Workforce infrastructure
• Enterprise goodwill
Frequently Asked Questions
Does every startup qualify for QSBS?
No. Certain businesses are expressly excluded by Code Section 1202.
Do SaaS companies qualify for QSBS?
Often yes, but qualification depends on the nature of the company's activities.
Are consulting firms excluded from QSBS?
Potentially. Consulting is one of the enumerated excluded service categories.
Can an AI company qualify for QSBS?
Many AI companies may qualify if they derive value from proprietary technology rather than personal services.
Qualified Trade or Business Checklist
• Nature of revenue streams
• Percentage of service revenue
• Proprietary intellectual property
• Recurring revenue sources
• Dependence on founder relationships
• Enterprise goodwill
• Organizational structure
• Subsidiary activities
Key Takeaways
Determining whether a company is engaged in a qualified trade or business is one of the most important and nuanced aspects of Code Section 1202 planning. Because qualification depends on a company's actual operations, revenue sources, intellectual property, and business model, founders should evaluate QSBS eligibility early and revisit the analysis as the business evolves.
Shaver Tax Law advises founders, investors, and emerging companies throughout California and nationwide on QSBS planning, Code Section 1202 qualification issues, and federal income tax matters.
