QSBS Opinion Letters
A tax opinion letter formally documents the analysis supporting your Section 1202 exclusion and may provide penalty protection under IRC 6662 if the position is later challenged.
When claiming a Section 1202 exclusion, the burden of proof rests with the taxpayer. You must be able to demonstrate that your stock met all the qualification requirements at the time of issuance and throughout the holding period.
A tax opinion letter is one way to document this analysis formally. It provides a written record of the legal reasoning supporting your QSBS claim.
What is a Tax Opinion Letter?
A tax opinion letter is a formal written analysis prepared by a tax attorney or CPA that applies the relevant IRC provisions to your specific facts. For QSBS, this means analyzing whether your stock meets the requirements under IRC 1202(c) (qualified small business stock), 1202(d) (qualified small business), and 1202(e) (active business requirements).
The opinion will typically conclude with a confidence level such as "more likely than not" (greater than 50% likelihood) or "should" (higher confidence) that your position would be sustained if challenged.
Potential Penalty Protection
Under IRC 6662, accuracy-related penalties of 20% may apply to underpayments attributable to negligence or substantial understatement of income tax.
However, these penalties may be avoided if the taxpayer had "reasonable cause" and acted in "good faith." Reliance on a qualified professional's opinion can help establish reasonable cause, though this is fact-specific.
Factors to Consider
Whether to obtain an opinion letter depends on your specific circumstances. Consider discussing with a tax professional if any of the following apply:
- • Straightforward C-Corp from incorporation
- • Clear active business operations
- • Standard stock issuance at founding
- • No entity conversions or restructuring
- • Converted from LLC or other entity
- • Stock redemptions occurred
- • Service-based business model
- • Significant investment assets held
The Active Business Requirement
IRC 1202(e)(3) lists specific business types that do not qualify, including any trade or business involving services performed in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services.
Additionally, businesses where the "principal asset" is the reputation or skill of one or more employees are excluded. For technology companies, the analysis often focuses on whether the company's value derives from its technology and intellectual property rather than individual expertise.
This is an area where professional guidance can be particularly valuable, as the distinction can be fact-intensive.
Need Professional Guidance?
A tax attorney or CPA specializing in Section 1202 can evaluate your specific situation and advise on documentation needs.