On November 19, Treasury and the IRS issued final regulations under section 512(a)(6) that provide guidance on how an exempt organization, subject to the unrelated business income tax, determines if it has more than one unrelated trade or business, and, if so, how the exempt organization calculates unrelated business taxable income (UBTI).
The Tax Cuts and Jobs Act added Internal Revenue Code Section 512(a)(6) which requires tax exempt organizations to calculate UBTI separately for each trade or business activity. This rule prevents organizations from using losses from one unrelated trade or business to offset income from a different unrelated trade or business. However, the statute did not include rules for determining whether an organization has more than one unrelated trade or business or for identifying different unrelated trades or businesses. Treasury and the IRS released interim guidance in Notice 2018-67 in August 2018 and released proposed regulations in April 2020.
The final regulations provide guidance on identifying separate trades or businesses using NAICS codes. The final regulations generally retain the proposed rule that a separate unrelated trade or business is identified by the NAICS 2-digit code that most accurately describes an exempt organization's trade or business activity. The final regulations provide some additional guidance, including that:
- The determination of which 2-digit code most accurately describes an exempt organization's activity is based on the more specific NAICS code, such as at the 6-digit level, that describes the activity.
- Descriptions in the current NAICS manual (available at census.gov) of trades or businesses using more than two digits of the NAICS codes are relevant in this determination.
- In the case of the sale of goods, both online and in stores, the separate unrelated trade or business is identified by the goods sold in stores if the same goods generally are sold both online and in stores.
- To the extent other services are provided in connection with a possible rental activity, income from the use of space may cease to be rent from real property and instead take on the character of the services provided.
The final regulations include additional guidance on the calculation of UBTI. The final regulations generally adopt the proposed rules for investment activities while providing detailed additional guidance on the aggregation rules provided for qualified partnership interests (QPI). In order for a partnership interest to be treated as a QPI, the proposed regulations required an exempt organization to (i) directly hold no more than 20% of the capital interest in the partnership; and (ii) not have control over the partnership. The final regulations retain this 20% threshold, despite numerous requests to increase to a 50% threshold. The final regulations rename the "control" test from the proposed regulations to the "significant participation" test, but generally look to the same factors to make this determination as the factors under the control test in the proposed regulations. Additionally, the final regulations expand a favorable "look-through rule" under the proposed regulations to permit an indirect interest in a lower-tier partnership that meets a de minimis test to be treated as a QPI even if the exempt organization significantly participates in the directly-held upper-tier partnership.
The final regulations also provide greater clarity regarding how the QPI rules apply to S corporation interests. The final regulations clarify that pre-2018 NOLs are taken against the total UBTI in a manner that allows for maximum utilization of post-2017 NOLs in a taxable year.
The final regulations expand upon a favorable proposed rule by permitting an exempt organization with more than one unrelated trade or business to determine public support using either its UBTI calculated under the silo rules or its UBTI calculated in the aggregate. The second option is intended to prevent the silo rules from having an adverse impact on the calculation of public support while the first option is intended to reduce the administrative burden of requiring two separate calculations of UBTI.
The final regulations are applicable to taxable years beginning on or after the date of publication in the Federal Register. In addition, an exempt organization may choose to apply the final regulations to earlier taxable years beginning on or after January 1, 2018. Alternatively, an exempt organization may rely on a reasonable, good-faith interpretation of section 512(a)(6) for such taxable years.