Earlier this week, Treasury posted an advance copy of the final regulations addressing how a tax-exempt organization subject to unrelated business income tax (UBIT) determines if it has more than one unrelated trade or business, and, if it does, how it calculates unrelated business taxable income (UBTI). The final regulations make minor modifications to the proposed regulations we wrote about in April (UBIT Silos: Proposed Regulations).
As we noted in the April post:
Under the law commonly known as the Tax Cuts and Jobs Act of 2017 (TCJA), an exempt organization with multiple unrelated business activities may not offset income from one line of activity with losses from another line of activity. For example, if a charity earns income from two unrelated business activities (referred to as “silos”) – (1) sale of advertising in its publications and (2) operation of a parking lot – and has $10,000 in profits from the advertising but $2,000 in losses from the parking, it may not apply the $2,000 in losses against the $10,000 in profits to determine its UBTI (which is something it could do prior to the TCJA). Any losses incurred from one unrelated business activity may be carried forward to future years indefinitely (carrybacks have been eliminated) but can only be used to offset income earned from the same activity. We have previously written on UBIT and some of the changes caused by the TCJA. See Unrelated Business Income Tax Explained; The New Tax Law and Its Impact on Nonprofits – Part 2; IRS Guidance on UBIT Silos – 512(a)(6) – PART I; IRS Guidance on UBIT Silos – 512(a)(6) – PART II.
The final regulations provide that an exempt organization generally must identify its separate unrelated trades or businesses using only the first two digits of the North American Industry Classification System (NAICS) codes. There are only 20 two-digit NAICS codes, each representing an industry sector. NAICS is an industry classification system for purposes of collecting, analyzing, and publishing statistical data related to the United States business economy. The system relies on business establishments to self-identify their proper 6-digit NAICS code numbers. See NAICS Lookup Help.
The exceptions to the required use of the NAICS codes are for income from certain investment activities, income from certain controlled entities, and income from a qualifying S-corporation interest. The rules are intricate, but the following represents some general applications, subject to certain exceptions or modifications in the regulations:
- Generally, an organization’s activities in the nature of investments (investment activities) are treated collectively as a separate unrelated trade or business for purposes of the silo rules.
- If a controlling organization receives specified payments from two different controlled entities, the payments from each controlled entity are treated as a separate unrelated trade or business.
- Generally, if an organization owns stock in an S corporation (S corporation interest), such S corporation interest is treated as an interest in a separate unrelated trade or business. Subject to a specific exception for S corporation ownership interests that meet the criteria for a qualifying partnership interest (QPI), if an organization owns two S corporation interests, the exempt organization reports two separate unrelated trades or businesses.
And from the regulations (which should be reviewed more carefully if an organization has a QPI), with additional emphasis for certain defined terms:
An interest in a partnership is a qualifying partnership interest (QPI) if the exempt organization holds a direct interest in the partnership (directly-held partnership interest) that meets the requirements of either the de minimis test (described in paragraph (c)(3) of this section) or the participation test (described in paragraph (c)(4) of this section).
A partnership interest is a QPI that meets the requirements of the de minimis test if the organization holds directly (within the meaning of paragraph (c)(2)(i) of this section) or indirectly (within the meaning of paragraph (c)(2)(ii) of this section) no more than 2 percent of the profits interest and no more than 2 percent of the capital interest during the organization’s taxable year with which or in which the partnership’s taxable year ends.
A partnership interest is a QPI that meets the requirements of the participation test if the organization holds directly (within the meaning of paragraph (c)(2)(i) of this section) or indirectly (within the meaning of paragraph (c)(2)(ii) of this section) no more than 20 percent of the capital interest during the organization’s taxable year with which or in which the partnership’s taxable year ends and the organization does not significantly participate in the partnership within the meaning of paragraph (c)(4)(iii) of this section. …
Final regs. govern computation of UBTI for separate businesses (Journal of Accountancy)
Final UBIT Basketing Rules Released (NACUBO)