The Tax Cuts and Jobs Act (TCJA) significantly changed the way exempt organizations calculate unrelated business taxable income (UBTI). Section 512(a)(6) of the TCJA provides that UBTI be calculated separately (or siloed) with respect to each trade or business and that one unrelated trade or business cannot net income (or loss) from another. This provision raises numerous questions, including how to identify a “trade or business,” how to treat income from debt-financed property and investment partnerships, how to report pre- and post-TCJA net operating losses (NOLs), and how to determine the effect of siloing on new fringe benefit provisions. Notice 2018-67 provides preliminary guidance and transition rules related to Section 512(a)(6) and on the treatment of global intangible low-taxed income (GILTI) under Section 951A for purposes of UBTI under Section 511.
Identifying a separate trade or business
Under the TCJA, Congress did not provide criteria for determining whether an exempt organization has more than one unrelated trade or business or for identifying separate unrelated trades or businesses. According to Notice 2018-67, exempt organizations may rely on a reasonable, good faith interpretation of the law to determine whether more than one unrelated trade or business exists. A reasonable, good faith interpretation includes using the North American Industry Classification System (NAICS) six-digit codes. However, the NAICS codes likely will not address many of the activities typically reported by exempt organizations. The notice also refers to several IRC sections and principles that might help determine whether an organization is engaged in a trade or business. The IRS and the U.S. Department of the Treasury request comments on whether NAICS codes, other methods, or a combination of methods might be more appropriate to identify separate trades or businesses.
Allocating directly connected deductions
Exempt organizations with an unrelated trade or business may deduct directly connected expenses – those with a proximate and primary relationship to the unrelated trade or business. Now, exempt organizations with more than one unrelated trade or business must allocate indirect expenses not only among exempt and taxable activities but also among separate unrelated trades or businesses. Exempt organizations might find it challenging to make these allocations. The IRS and Treasury currently have an item on the Priority Guidance Plan about how to allocate expenses related to dual-use facilities. Treasury and the IRS request comments regarding possible rules or defined allocation standards.
Income treated as gross income from UBTI
Certain income items – such as unrelated debt financed income (UDFI), specified payments received from controlled entities, and certain insurance income – are considered gross income from an unrelated trade or business. The IRS and Treasury acknowledged that exempt organizations might interpret the TCJA to require, for example, that each debt-financed property be reported as a separate trade or business because separate calculations might be necessary to determine the amount of UDFI. According to the notice, however, an exempt organization may aggregate such income included in UBTI under certain circumstances. Aside from the example provided in the notice, it is unclear under what circumstances an organization may be able to aggregate such income under Section 512(a)(6).
Investments in partnership interests
Exempt organizations with partnership interests feared that the activities within an investment partnership (such as a multitiered partnership) would have to be separately tracked and reported under Section 512(a)(6). Notice 2018-67 provides some relief. Generally, under this interim rule, an exempt organization may aggregate its UBTI from its interest in a single partnership with multiple trades or businesses, as long as the directly held interest meets either of two tests (a “qualifying partnership interest”):
Fringe benefits
Certain fringe benefits (including qualified transportation fringes) are includible as UBTI under Section 512(a)(7) under the TCJA. However, the IRS and Treasury believe that fringe benefits includible as UBTI are not subject to Section 512(a)(6). Seemingly, if an organization has only one unrelated trade or business, a loss from that activity may offset amounts includable as UBTI under Section 512(a)(7). Alternatively, if an organization has more than one unrelated trade or business that causes Section 512(a)(6) to apply, it is unclear whether or how Section 512(a)(7) income may be offset by any unrelated trade or business loss.
Net operating losses
The TCJA permits the carryover of any pre-2018 NOLs to offset UBTI in future years. However, organizations must calculate UBTI separately with respect to each trade or business for tax years beginning after Dec. 31, 2017, and may take an NOL deduction only with respect to the trade or business from which it arose. The notice recognizes that application of the NOL provisions creates challenges for exempt organizations. The IRS and Treasury requested comments on two primary issues: 1) the ordering of pre-2018 and post-2017 NOLs and the potential treatment of pre-2018 NOLs that might expire in a given tax year if not taken before post-2017 NOLs and 2) the application of the 80 percent income limitation under Section 172, particularly when the organization has both pre-2018 and post-2017 NOLs.
Global intangible low-taxed income
The notice provides guidance on the GILTI inclusions as they relate to tax-exempt investors. In general, it confirms that the IRS will view GILTI as similar to Subpart F – as a dividend generally excluded from UBTI.
Clarity is forthcoming
The notice might not provide the news that many exempt organizations were seeking – a delay in implementation of the rules – but it does provide preliminary guidance and insight into what proposed regulations might cover, and it raises legitimate questions for further consideration.
Identifying a separate trade or business
Under the TCJA, Congress did not provide criteria for determining whether an exempt organization has more than one unrelated trade or business or for identifying separate unrelated trades or businesses. According to Notice 2018-67, exempt organizations may rely on a reasonable, good faith interpretation of the law to determine whether more than one unrelated trade or business exists. A reasonable, good faith interpretation includes using the North American Industry Classification System (NAICS) six-digit codes. However, the NAICS codes likely will not address many of the activities typically reported by exempt organizations. The notice also refers to several IRC sections and principles that might help determine whether an organization is engaged in a trade or business. The IRS and the U.S. Department of the Treasury request comments on whether NAICS codes, other methods, or a combination of methods might be more appropriate to identify separate trades or businesses.
Allocating directly connected deductions
Exempt organizations with an unrelated trade or business may deduct directly connected expenses – those with a proximate and primary relationship to the unrelated trade or business. Now, exempt organizations with more than one unrelated trade or business must allocate indirect expenses not only among exempt and taxable activities but also among separate unrelated trades or businesses. Exempt organizations might find it challenging to make these allocations. The IRS and Treasury currently have an item on the Priority Guidance Plan about how to allocate expenses related to dual-use facilities. Treasury and the IRS request comments regarding possible rules or defined allocation standards.
Income treated as gross income from UBTI
Certain income items – such as unrelated debt financed income (UDFI), specified payments received from controlled entities, and certain insurance income – are considered gross income from an unrelated trade or business. The IRS and Treasury acknowledged that exempt organizations might interpret the TCJA to require, for example, that each debt-financed property be reported as a separate trade or business because separate calculations might be necessary to determine the amount of UDFI. According to the notice, however, an exempt organization may aggregate such income included in UBTI under certain circumstances. Aside from the example provided in the notice, it is unclear under what circumstances an organization may be able to aggregate such income under Section 512(a)(6).
Investments in partnership interests
Exempt organizations with partnership interests feared that the activities within an investment partnership (such as a multitiered partnership) would have to be separately tracked and reported under Section 512(a)(6). Notice 2018-67 provides some relief. Generally, under this interim rule, an exempt organization may aggregate its UBTI from its interest in a single partnership with multiple trades or businesses, as long as the directly held interest meets either of two tests (a “qualifying partnership interest”):
- The de minimis test is met if the organization directly holds 2 percent or less in capital interest and 2 percent or less in profits interest.
- The control test is met if the organization directly holds no more than 20 percent of the capital interest and does not have control or influence over the partnership.
Fringe benefits
Certain fringe benefits (including qualified transportation fringes) are includible as UBTI under Section 512(a)(7) under the TCJA. However, the IRS and Treasury believe that fringe benefits includible as UBTI are not subject to Section 512(a)(6). Seemingly, if an organization has only one unrelated trade or business, a loss from that activity may offset amounts includable as UBTI under Section 512(a)(7). Alternatively, if an organization has more than one unrelated trade or business that causes Section 512(a)(6) to apply, it is unclear whether or how Section 512(a)(7) income may be offset by any unrelated trade or business loss.
Net operating losses
The TCJA permits the carryover of any pre-2018 NOLs to offset UBTI in future years. However, organizations must calculate UBTI separately with respect to each trade or business for tax years beginning after Dec. 31, 2017, and may take an NOL deduction only with respect to the trade or business from which it arose. The notice recognizes that application of the NOL provisions creates challenges for exempt organizations. The IRS and Treasury requested comments on two primary issues: 1) the ordering of pre-2018 and post-2017 NOLs and the potential treatment of pre-2018 NOLs that might expire in a given tax year if not taken before post-2017 NOLs and 2) the application of the 80 percent income limitation under Section 172, particularly when the organization has both pre-2018 and post-2017 NOLs.
Global intangible low-taxed income
The notice provides guidance on the GILTI inclusions as they relate to tax-exempt investors. In general, it confirms that the IRS will view GILTI as similar to Subpart F – as a dividend generally excluded from UBTI.
Clarity is forthcoming
The notice might not provide the news that many exempt organizations were seeking – a delay in implementation of the rules – but it does provide preliminary guidance and insight into what proposed regulations might cover, and it raises legitimate questions for further consideration.
