On April 23, the U.S. Department of the Treasury and the IRS issued proposed regulations under Section 512(a)(6), which was enacted by the Tax Cuts and Jobs Acts of 2017. Section 512(a)(6) requires tax-exempt organizations to calculate unrelated business taxable income (UBTI) separately with respect to each trade or business. Section 512(a)(6) also provides that losses from one unrelated trade or business cannot offset the gains from another. Comments on the proposed regulations are due by June 23, 2020.
The proposed regulations expand on interim guidance and transition rules provided in Notice 2018-67, which was issued on Aug. 21, 2018. Following are highlights of the proposed regulations:
Trade or business determination. An exempt organization must identify its separate unrelated business trades or businesses using the first two digits of the North American Industry Classification System (NAICS) codes (which would identify trades or businesses in 20 sectors) rather than by the six-digit NAICS codes as provided in the notice. This change is significant and is intended to minimize implementation costs and mitigate the administrative burden on exempt organizations.
Investment activities. The investment activities that can be treated as one separate unrelated trade or business are limited to:
- Qualifying partnership interests (QPIs)
- Debt-financed properties
- Qualifying S-corporation interests
A partnership interest is a QPI if it meets the requirements of either the de minimis test or the control test.
- Generally, a partnership interest meets the de minimis test if the exempt organization directly holds no more than 2% of the profits interest and no more than 2% of the capital interest. Unlike the notice, the proposed regulations do not require that related interests be combined to determine if the de minimis test is met. Additionally, exempt organizations are permitted to aggregate any indirectly held partnership interests that meet the requirements of the de minimis test with all other QPIs (look-through rule).
- Generally, a partnership interest meets the control test if the exempt organization holds no more than 20% of the capital interest and does not control the partnership. All the facts and circumstances are relevant for determining whether an exempt organization controls a partnership, including the partnership agreement.
Transition rule. An exempt organization is permitted to treat as one trade or business each partnership interest acquired prior to Aug. 21, 2018, that failed to meet the de minimis test or the control test. This transition rule may be relied on only until the first day of the organization’s first taxable year beginning after the date regulations are published as final. Exempt organizations may apply either the transition rule or the look-through rule, but not both, to a partnership interest.