No big surprises in final siloing regs, but planning opportunities exist

| 12/3/2020
No big surprises in final siloing regs, but planning opportunities exist

On Nov. 19, the U.S. Department of the Treasury and the IRS released final regulations under IRC Section 512(a)(6), which was enacted by the Tax Cuts and Jobs Acts of 2017. Section 512(a)(6) requires exempt organizations to calculate unrelated business taxable income separately with respect to each trade or business. Section 512(a)(6) also provides that losses from one unrelated trade or business cannot offset gains from another.

With some exceptions, the final regulations largely adopt earlier guidance provided in proposed regulations issued on April 3, 2020, and in Notice 2018-67 issued on Aug. 21, 2018. Following are highlights of the final regulations.

Trade or business determination. The final regulations retain the two-digit North American Industry Classification System (NAICS) code methodology from the proposed regulations for identifying separate trades or businesses. The final regulations remove the restriction on changing two-digit NAICS codes once established. Revised Form 990-T, “Exempt Organization Business Income Tax Return (and Proxy Tax Under Section 6033(e)),” instructions will explain how to report code changes.

Expense allocation. The unrelated business income rules permit an allocation of dual-use expenses of facilities or personnel between related and unrelated uses on a “reasonable” basis. The IRS long has signaled an intention to issue additional guidance on this matter rather than relying on a broad reasonableness standard. While Treasury and the IRS continue to consider and expect to publish further guidance, the final regulations clarify that expense allocation is not reasonable if the cost of providing a good or service in a related and an unrelated activity is substantially the same, but the price charged for the unrelated activity is greater than the price charged for the related activity, with no equalizing adjustment made.

Investment activities. The final regulations continue to allow certain investment income from qualifying partnership interests (QPIs), debt-financed properties, and qualifying S-corporation interests to be aggregated and treated as a single trade or business. A partnership interest is a QPI if it meets either the de minimis test or the participation test (formerly the control test).

  • The de minimis test is met if the exempt organization holds, directly or indirectly, no more than 2% of the profits interest and no more than 2% of the capital interest.
  • The participation test is met if the exempt organization directly holds no more than 20% of the capital interest and does not significantly participate in the partnership. Under the participation test, the interests of a supporting organization (other than a Type III supporting organization that is not a parent of its supported organizations) or a controlled entity in the same partnership are considered when determining an organization’s percentage interest in a partnership. The final regulations eliminate use of a general facts and circumstances test but retain the four factors set forth in the proposed regulations that evidence significant participation with modifications. These modifications clarify that an exempt organization does not significantly participate in a partnership based on the ability to prevent an action of the partnership due to a unanimous vote requirement or through minority consent rights.

In addition, the final regulations expand the look-through rule, which now permits certain indirectly held partnership interests to be QPIs even though the directly held upper-tier partnership interest meets neither the de minimis test nor the participation test.

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Charitable contribution deductions. The final regulations clarify that a deduction for charitable contributions must be taken against the total unrelated business taxable income of the organization and not allocated among silos. The final regulations do not address the coordination of net operating loss (NOL) deductions and excess charitable contribution carryovers.

NOL deductions. The final regulations provide that when an organization has both pre-2018 NOLs and post-2017 NOLs, pre-2018 NOLs are deducted first in a manner that results in maximum use of pre-2018 NOLs. The final regulations also address how to handle NOL carryforwards when the organization changes the NAICS code, when a QPI no longer is treated as such, and upon disposition of a separately identified trade or business. The final regulations do not address how the changes made to Section 172 by the Coronavirus Aid, Relief, and Economic Security Act that allow enhanced opportunities for NOL carrybacks affect exempt organizations.

Form 990-T. On Form 990-T, investment activities, specified payments from controlled entities, certain amounts derived from controlled foreign corporations, and nonqualifying S-corporation interests will be distinguished using a numeric code apart from NAICS codes.

Reliance and applicability. The final regulations apply to tax years beginning on or after Dec. 2, 2020. Exempt organizations may apply the final regulations to tax years beginning on or after Jan. 1, 2018, and before Dec. 2, 2020. Alternatively, they may rely on a reasonable, good faith interpretation of Section 512(a)(6) (which includes the methods of aggregating or identifying separate trades or businesses provided in Notice 2018-67 or the proposed regulations).

Planning opportunities. The final regulations create planning opportunities, including NAICS code assignment and changes, expense allocation methodology review, analysis of partnership interests under the participation test, and maximization of NOL deductions.

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