Memorandum

Office of Chief Counsel

Internal Revenue Service

Memorandum

Number: 202204007

Release Date: 1/28/2022

CC:ITA:B05:RFBoone

POSTS-119006-20

Third Party Communication: None

Date of Communication: Not Applicable

UILC:

1202.00-00

date:

November 04, 2021

to:

David M. Carl

Attorney (SBSE, Group 2)

(Small Business/Self-Employed)

from:

Erika C. Reigle

Senior Technical Reviewer, Branch 5

(Income Tax & Accounting)

subject:

Section 1202 and Brokerage Services

This Chief Counsel Advice responds to your request for assistance. This advice may

not be used or cited as precedent.

LEGEND

Corporation = -------------------

Taxpayer = ---------------------------------------------

ISSUES

Does a business that facilitates the leasing of property between lessors and lessees

constitute a business involving the performance of services in the field of brokerage

services within the meaning of § 1202(e)(3)(A) of the Internal Revenue Code?

CONCLUSIONS

A business that facilitates the leasing of property between lessors and lessees

constitutes a business that involves the performance of services in the field of

brokerage services within the meaning of § 1202(e)(3)(A).

POSTS-119006-20 2

FACTS

Taxpayer sold stock in Corporation. Corporation operates a website on which potential

lessees may use the website to make nonbinding reservations for the use of certain

facilities at specified rental rates from facility lessors that are included in the website

data base. Corporation has no authority to enter into or sign leases on behalf of the

potential lessors or lessees. A legally binding rental agreement for the use of a facility

does not arise until the potential lessor and the potential lessee enter into a lease

agreement. Corporation’s website will show a user that is considering leasing one or

more facilities in a particular location the facilities in that area that are included in the

website data base.

Potential lessees do not pay any fee to Corporation for the use of Corporation’s website.

In its “Terms of Service” for lessees, Corporation states that it has no control over the

facilities to be leased and does not guarantee the accuracy of any listings. Nor does

Corporation guarantee that a lessee will actually be able to lease a facility listed in its

database.

The lessors are responsible for all payments to Corporation. As a condition of being

listed in Corporation’s public, searchable database, lessors agree to compensate

Corporation. Specifically, Corporation charges lessors a recurring periodic fee for

simply being listed in the database, and a contingent fee based on a percentage of rent

paid by a lessee actually leasing a facility from a lessor through a search of

Corporation’s database. Corporation requires lessees to pay the rent for the leased

facility through Corporation’s website.

The facilities listed for lease on Corporation’s website include real property. In

Corporation’s “Terms of Service,” Corporation represents to potential lessees that its

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----------------” Corporation states that it is not responsible for, and does not engage in,

brokering, selling, purchasing, exchanging, or leasing posted properties. Although it

may hold a real estate broker license in one or more states, Corporation asserts that it

is not a broker with respect to the leasing of the facilities. Further, a lessee’s use of the

website constitutes an acknowledgement that Corporation has pre-negotiated rental

rates with the lessors included on its website, part of which will be retained by

Corporation as compensation for its services.

Corporation may also provide other services to lessors. For example, Corporation may

charge a lessor a monthly fee to build and host a website for the lessor to be used in

conjunction with the leasing of the lessor’s facility. Liability for this monthly fee is not

contingent on the lessor successfully leasing its facility to potential lessees.

LAW AND ANALYSIS

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A. Section 1202

For taxpayers other than corporations, under § 1202(a), gross income shall not include

a certain percentage of any gain from the sale or exchange of qualified small business

stock (QSB stock) held for more than 5 years. The gain exclusion is 100% for QSB

stock acquired after September 27, 2010, 75% for QSB stock acquired after February

17, 2009 and before September 28, 2010, and 50% for QSB stock acquired on or

before February 17, 2009.

Section 1202(c) provides that, in general, QSB stock means any stock in a C

corporation which is originally issued after the date of enactment of the Revenue

Reconciliation Act of 1993 (Omnibus Budget Reconciliation Act of 1993, P.L. 103-66, §

13113(a)) if: 1) on the date of the stock’s issuance such corporation is a qualified small

business; and 2) such stock is acquired by the taxpayer at its original issue in exchange

for money or other property or as compensation for services.

Section 1202(c)(2)(A) requires that in order to be treated as QSB stock, during

substantially all of the taxpayer’s holding period for such stock, the corporation issuing

the stock must satisfy the active trade or business requirement of § 1202(e). This

requires the corporation to use at least 80 percent of its assets (by value) in the active

conduct of one or more qualified trades or businesses.

Generally, an active trade or business is any trade or business other than trades or

businesses expressly listed in § 1202(e)(3). Section 1202(e)(3)(A) specifically provides

that a trade or business involving the performance of services in various fields, including

brokerage services, is not an active trade or business under § 1202(e)

1

.

B. Brokerage Services

There are two primary possibilities for characterizing the services provided by

Corporation. First, it is simply providing advertising services. Second, Corporation’s

services extend beyond passive advertising and constitute the provision of brokerage

services.

1. Statutory and Regulatory Definitions for Federal Tax Purposes

As stated above, the term “brokerage services” is not defined in § 1202 nor is it

explained in the legislative history to § 1202, which simply repeats the term without any

elaboration on its meaning. See H.R. Rep. No. 111, 103d Cong., 1st Sess. 601 (1993).

Outside of § 1202(e)(3)(A), several other Code sections and Federal income tax

regulations discuss the definition of “brokerage services”. Because § 1202(e) does not

1

Section 1202(e)(3) also provides that certain other trades or businesses are not qualified trades or

businesses. This list includes, among others, any farming business, operation of a hotel, motel or

restaurant, and any banking, insurance, financing, leasing, investing or similar business.

POSTS-119006-20 4

contain a definition of the terms used, it is instructive to look to other Code sections.

Specifically, we look to §§ 6045, 448 and 199A for guidance.

2

For information reporting purposes, § 6045(a) requires every person doing business as

a broker to file information returns regarding the person’s customers in accordance with

regulations issued by the Secretary. Section 6045(b) also requires the person doing

business as a broker to provide a statement to the customer. The term broker is

broadly defined in the statute without any restriction to a particular type of business.

Specifically, § 6045(c)(1) provides that the term broker includes—(A) a dealer, (B) a

barter exchange, and (C) any other person who (for a consideration) regularly acts as a

middleman with respect to property or services.

Treas. Reg. § 1.6045-1 similarly broadly defines the term “broker” to include “any

person (other than a person who is required to report a transaction under section 6043),

U.S. or foreign, that, in the ordinary course of a trade or business during the calendar

year, stands ready to effect sales to be made by others.” Notwithstanding this broad

statutory and regulatory definition of broker, in promulgating the regulations under

section 6045, Treasury chose to limit the types of assets, the sale of which would be

subject to broker reporting. Specifically, Treas. Reg. § 1.6045-1(a)(9) defines a “sale”

as dispositions of securities, commodities, options, regulated futures contracts,

securities futures contracts, or forward contracts, and includes redemptions of stock,

retirements of debt instruments, entering into short sales for cash, and in the case of an

option, a regulated futures contract, a securities futures contract, or a forward contract,

a sale includes any closing transaction. Notwithstanding that the definition of sale in

Treas. Reg. § 1.6045-1(a)(9) effectively limits the types of “brokers” who will have an

obligation to make information reports, the statutory and regulatory definition of broker

nonetheless remains broad enough to apply to Corporation’s website operations.

In 1986, Congress added real estate transactions to the types of transactions for which

broker reporting is required under section 6045. See § 6045(e). Recognizing that many

people may be involved in facilitating real estate transactions, however, Congress

provided a specific ordering rule to ensure that only one person would be treated as the

“broker” with the obligation to report on the real estate transaction. See § 6045(e)(2).

Specifically, the “real estate reporting person” to be treated as a broker includes the

following persons (in order): the person responsible for closing the transaction, the

mortgage lender, the seller’s broker, the buyer’s broker, or such other person

designated in the regulations. This reporting regime for real estate brokers shows that

Congress understood that the term broker had an expansive meaning, certainly broad

enough in this context to apply to Corporation’s lease facilitation operations.

Section 448(a) generally requires C corporations and partnerships that have a C

corporation as a partner to use the accrual method of accounting if such entities meet a

gross receipts test

3

. However, § 448(b)(2) treats a qualified personal service

2

While other Code sections may discuss brokers or brokerage services, §§§ 448, 6045(a) and 199A are

the most applicable to § 1202 as they provide the clearest guidance as to the definition.

3

Section 448(a) also requires tax shelters to use the accrual method of accounting.

POSTS-119006-20 5

corporation (QPSC) as an individual, thereby creating an exception to the accrual

method requirement for such C corporations and partnerships whose only C corporation

partners are QPSCs. Section 448(d)(2) requires that substantially all of the activities of

the corporation involve the performance of services in the fields of health, law,

engineering, architecture, accounting, actuarial science, performing arts, or consulting.

These activities also constitute a subset of the trades or businesses that fail to meet the

test for a qualified trade or business under § 1202(e)(3)(A).

Notably absent from the list of activities that can qualify a C corporation as a QPSC

under § 448(d)(2) are the performance of activities in the field of brokerage services.

Nevertheless, the § 448 regulations provide that consulting services do not include the

performance of services other than advice and counsel, such as sales or brokerage

services, or economically similar services. See Treas. Reg. § 1.448-1T(e)(4)(iv)(A).

The regulations provide that whether a person's services are sales or brokerage

services, or economically similar services is based on all the facts and circumstances of

that person's business, including the manner in which the taxpayer is compensated for

the services (e.g., whether the compensation for the services is contingent upon the

consummation of the transaction that the services were intended to effect). Id. Treas.

Reg. § 1.448-1T(e)(4)(iv)(B) provides several examples of the application of this rule,

which has the corollary effect of providing some indication as to what constitutes sales

services, brokerage services, or services economically similar to brokerage services.

The examples distinguish consulting from sales services, as well as brokerage services

and economically similar services. What triggers the taxpayer’s right to compensation

appears to be a major factor in making this determination. It appears that if the

taxpayer is compensated for advising and counseling the client, the services constitute

consulting

4

. If, no matter how much effort the taxpayer expends advising and making

recommendations to the client, the taxpayer is only compensated if the client engages

in specific transactions, the services are not for consulting.

For instance, in Example 5, the taxpayer executes transactions for customers involving

various types of securities or commodities generally traded through organized

exchanges or other similar networks. The taxpayer also provides clients with economic

analyses and forecasts of conditions in various industries and businesses, and based

on these analyses, the taxpayer recommends that the taxpayer engage in certain

transactions involving securities and/or commodities. However, the taxpayer's

compensation is typically based on actual trades made by clients. Example 5

concludes that the taxpayer is providing brokerage services.

5

4

The consulting examples do not expressly provide that the taxpayer is compensated based on hourly

billing rates or some other metric not based on commissions for executed transactions. However, notably

absent from the consulting examples are any indications that the taxpayer’s compensation is commission

based.

5

Although Example 10 concludes that the taxpayer is engaged in the performance of brokerage or sales

services, it does not state whether the taxpayer’s services are in the nature of brokerage or sales

services. In that example the taxpayer sells insurance, annuities, and other similar insurance products.

The taxpayer studies the client's financial situation, business and personal insurance risks, and

POSTS-119006-20 6

The regulation’s goal is to provide guidance as to what constitutes the performance of

services in the field of consulting. As brokerage services are not consulting services

under the regulation, the examples do not provide enough facts or criteria to allow a

reader to distinguish between sales services

6

, brokerage services, and services

economically similar to brokerage services.

7

Finally, § 199A(d)(2)(A) references § 1202(e)(3)(A) in its list of trades or businesses that

are specified service trades or businesses. In 2019, Treasury issued regulations that

expressly define the performance of brokerage services in the context of § 199A.

However, these regulations only apply for purposes of § 199A.

8

anticipated future economic and financial needs. Based on this study, the taxpayer recommends various

insurance products to the client. The client then may purchase various insurance products through the

taxpayer. The taxpayer's compensation for its services is typically based on the purchases made by the

clients. The example does not make clear whether the taxpayer is a dedicated sales agent for a

particular insurance company, in which case we would consider the taxpayer to be providing sales

services, or if the taxpayer is an independent insurance agent that could obtain insurance contracts for

the client from multiple insurance companies, in which case we would consider the taxpayer to be an

insurance broker.

6

In Example 6 the taxpayer studies a client's data processing needs and makes recommendations to the

client regarding the design and implementation of data processing systems. The client then may order

computers and other data processing equipment through the taxpayer based on the taxpayer's

recommendations. The taxpayer's compensation for its services is typically based on the equipment

orders made by the clients. Example 6 concludes that the taxpayer is providing sales rather than

consulting services. The example does not specify whether the taxpayer is also the party that provides

the computers and data processing equipment, is a dedicated sales agent for a single manufacturer or

distributor of computers and other data processing equipment, or works as an independent agent on

behalf of clients to arrange a sales transaction between the client and one or more manufacturers or

distributors of computers and data processing equipment. Our assumption is that the taxpayer is a sales

agent for one manufacturer or distributor of computers and other data processing equipment.

7

In Example 7 the taxpayer assists clients in meeting their personnel needs by referring job applicants to

the clients with hiring needs in a particular area. The taxpayer's compensation for its services is typically

based on the job applicants, referred by the taxpayer to the clients, who accept employment positions

with the clients. In Example 9 the taxpayer assists clients in placing advertisements for their goods and

services. The taxpayer analyzes the conditions and trends in the client's particular industry, and then

makes recommendations to the client regarding the types of advertisements which should be placed by

the client and the various types of advertising media (e.g., radio, television, magazines, etc.) which should

be used by the client. The taxpayer's compensation for its services is typically based on orders for

advertisements which the client makes. In both examples the regulations conclude that the taxpayers are

engaged in the performance of services economically similar to brokerage services. The regulations

provide no criteria for distinguishing brokerage services from services economically similar to brokerage

services.

8

Treas. Reg. § 1.199A-5(b)(2)(i) provides that the rules of § 1.199A-5(b)(2) apply solely for purposes of §

199A and therefore may not be taken into account for purposes of applying any provision of law or other

regulation other than § 199A and the regulations thereunder, except to the extent such provision

expressly refers to § 199A(d) or Treas. Reg. § 1.199A-5.

POSTS-119006-20 7

Treas. Reg. § 1.199A-5(b)(2)(x) provides that for purposes of § 199A(d)(2) and Treas.

Reg. § 1.199A-5(b)(1)(ix) only, the performance of services in the field of brokerage

services includes services in which a person arranges transactions between a buyer

and a seller with respect to securities (as defined in § 475(c)(2)) for a commission or

fee, including stock brokers and other similar professionals but does not include

services by real estate agents and brokers, or insurance agents and brokers.

2. Dictionary Definitions

We have found no case law that addresses the issue of what constitutes “brokerage

services” for federal income tax purposes. However, in the absence of evidence to the

contrary, words in a statute are assumed to bear their ordinary, contemporary, common

meaning. Pioneer Investment Services Co. v. Brunswick Associates Ltd. Partnership,

507 U.S. 380, 388 (1993). To ascertain the meaning of statutory terms, courts often

take into account the definitions of those terms in dictionaries. See e.g. Walters v.

Metropolitan Educational Enterprises, Inc., 519 U.S. 202, 207 (1997); Metro One

Telecommunications, Inc. v. Commissioner, 704 F.3d 1057, 1061 (9th Cir. 2012).

One popular dictionary definition of broker defines the term similar to the definition of

broker under § 6045. Specifically, Merriam-Webster defines “broker” 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).

BLACK’S LAW DICTIONARY (11th ed. 2019) provides a more elaborate definition of broker,

stating, “One who is engaged for another, usually on a commission, to negotiate

contracts to property in which he or she has no custodial or proprietary interest, or an

agent who acts as an intermediary or negotiator, especially between prospective buyers

and sellers.”

Another definition of ‘broker’ provides that the most important factor determining

whether a person is a broker is whether the party is dealing for itself or for another.

Further, a broker must be acting for compensation and on behalf of someone else. See

12 Am. Jur. 2d Brokers § 1 (1997).

There are all kinds of parties who are referred to as brokers. A few examples include

aircraft brokers, freight brokers, real estate brokers, business brokers, yacht brokers,

ship brokers, stockbrokers, commodities brokers, insurance brokers, broker-dealers,

auto transport brokers, mortgage brokers, list brokers (for direct mail), intellectual

property brokers, produce brokers, customs brokers, and pawnbrokers.

The latter two types of brokers are not brokers as defined above. A pawnbroker

functions as a dealer in used property but its primary business is that of a secured

POSTS-119006-20 8

lender that takes possession of the collateral securing the loan. With respect to

importing goods into the United States, a customs broker generally aids parties in

complying with import laws and regulations.

Thus, the mere fact that a party is referred to as a broker does not in and of itself mean

that the party is a broker within the scope of the definitions set forth above. Likewise,

the fact that a party is not commonly referred to as a broker does not, in and of itself,

foreclose the possibility that the party is a broker within the scope of the definitions set

forth above.

C. Is Corporation providing Brokerage Services Under § 1202(e)(3)(A)

Section 61(a) provides a broad definition of gross income, stating that except as

otherwise provided, gross income means all income from whatever source derived. The

Supreme Court, in Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 429 (1955),

emphasized the sweeping and encompassing nature of § 61(a). See also United States

v. Burke, 504 U.S. 229, 233 (1992); Helvering v. Clifford, 309 U.S. 331, 334 (1940).

As a corollary to the idea that gross income should be broadly construed, exclusions

from gross income must be narrowly interpreted. See Commissioner v. Schleier, 515

U.S. 323, 328 (1995); United States v. Burke, 504 U.S. at 248 (Souter, J. concurring in

judgment); United States v. Centennial Savings Bank FSB, 499 U.S. 573, 583-584

(1991); Commissioner v. Jacobson, 336 U.S. 28, 49 (1949).

Section 1202 excludes from gross income all or a portion of the gain from the sale of

QSB stock. Section 1202(e)(3) provides a list of activities that do not satisfy the active

business requirement of a qualified trades or business, including brokerage services.

These activities limit the scope of the § 1202 exclusion. Precedent, therefore, supports

the Service in interpreting the term “brokerage services” broadly, so as to provide a

narrow construction of the exclusion.

We may, in our discretion, look to other Code sections and commonly understood

definitions to help define the terms used in § 1202(e), including “brokerage services.” In

§ 199A, for example, the definition of who is a broker is quite narrow, extending only to

include those who deal with securities. In § 199A, interpreting ”broker” narrowly furthers

the overall purpose of the provision to provide nonincorporated businesses with a lower

effective rate of tax following the reduction of the corporate rate. For § 199A, tax policy

is furthered by narrowly limiting the definition of “broker” to one who only deals in

securities. Using a similarly narrow definition of brokerage services would not, however,

further the tax policy goals of § 1202.

In contrast, the definition of broker in § 6045 is quite broad and includes any person

who regularly acts as a middleman with respect to property or services (including real

estate) that the Secretary determines should be subject to reporting. In contrast to

§199A, tax policy is furthered by an expansive definition of ‘broker’ under § 6045

because limited third-party information reporting to the IRS is an important factor

POSTS-119006-20 9

contributing to the tax gap—which is the difference between taxes legally owed and

taxes actually paid. GAO, Tax Gap: Multiple Strategies Are Needed to Reduce

Noncompliance, GAO-19-558T at 6 (Washington, D.C.: May 9, 2019).

Section 448(d)(2) excludes “qualified personal service corporations” from required use

of the accrual method, whereas § 1202(e)(3)(A) denies the tax benefits of § 1202 to

stockholders of businesses that do not satisfy the definition of qualified trades or

businesses. However, both statutes define the applicable businesses in terms of the

services that the businesses perform. While the § 448 regulations do not specifically

define ”brokerage services”, they do differentiate between consulting services (a

qualified business for § 448(d)(2) purposes) which involve advising and counseling

clients, from services similar to brokerage services, which involve compensation for the

client engaging in a specific transaction.

We conclude that Corporation should be classified as a broker under the common

meaning of the term and as it is defined under § 6045, rather than the more narrow

definition that applies for purposes of § 199A.

9

While Corporation states that it does not

provide brokerage services but instead provides advertising services, it is our view that

the actions and services provided by Corporation support our position that Corporation

is a broker for purposes of § 1202(e)(3)(A).

A broker serves as an intermediary between a buyer and a seller, and Corporation does

this. Corporation does not just passively publish advertisements on its website that are

provided to it from potential lessors desiring to lease property. Unlike a search engine

that provides content to users and also sends targeted advertisements to those users

based on their search history, Corporation’s website is solely devoted to effectuating

agreements between potential lessors and potential lessees of certain property.

Corporation charges a minimum flat fee to lessors irrespective of whether a potential

lessor succeeds in entering into lease agreements as a result of the use of

Corporation’s website. However, Corporation is also compensated on a commission

basis based on leasing transactions that are entered into as the result of the use of

Corporation’s website.

Corporation does not have the authority to enter into leasing agreements on behalf of

lessors that use its services. Corporation only provides a vehicle for potential lessees to

transmit non-binding reservation requests to potential lessors. Only the potential lessor

and lessee have the authority to enter into a binding lease agreement. However,

brokerage activity can include simply bringing a potential buyer and seller together to

work out the transaction. See American West Hotel Brokers v. Wu, 697 P.2d 34, 36

(Colo. 1985).

9

It is important to emphasize that the §199A regulations’ narrow interpretation of what constitutes

brokerage services by its terms only applies for purposes of § 199A and no other Code section. Further,

the examples in the section 448 regulations confirm the common meaning of the term brokerage services.

POSTS-119006-20 10

The fact that Corporation’s services are provided by software created by people rather

than directly by people does not change the functional nature of the services. Because

Corporation provides brokerage services within the meaning of § 1202(e)(3)(A),

taxpayer is not entitled to exclude any of the gain from the sale of stock in Corporation

under § 1202.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

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writing may undermine our ability to protect the privileged information. If disclosure is

determined to be necessary, please contact this office for our views.

Please call (202) 317-7006 if you have any further questions.