December 7, 2020
On November 19, Treasury and the IRS released final regulations, T.D. 9933, providing guidance on Internal Revenue Code section 512(a)(6). The guidance clarifies how a tax-exempt organization determines if it has more than one unrelated trade or business, and if so, how to calculate its unrelated business taxable income (UBTI).
Section 512(a)(6), added by the 2017 Tax Cuts and Jobs Act (TCJA), requires exempt organizations to calculate UBTI and related NOLs separately for each unrelated trade or business. Prior to the enactment of the TCJA, organizations determined their UBTI liability on an aggregated basis. Introduction of this new “siloing” concept raised many questions for exempt organizations, as neither the TCJA nor the Internal Revenue Code define what constitutes a “separate” trade or business for these purposes.
In August 2018, the IRS released interim temporary guidance (Notice 2018-67) providing some additional insights on application of the siloing rules. This notice instructed exempt organizations to determine if they had a separate trade or business based on any reasonable method, and provided that it may (but are not required to) use the North American Industry Classification System (NAICS) 6-digit codes to group activities. In April 2020, the IRS released proposed regulations providing additional guidance and clarification. The proposed regulations stated that NAICS 2-digit codes should be used to determine different silo activities. The revision in guidance from use of the 6-digit codes to the 2-digit codes reduced the possible number of silos from 1,000 codes to 20 different codes, slightly easing the administrative burden of grouping activities. The final regulations released in November maintain use of the 2-digit codes.
The final regulations also provide guidance on the silo rules relating to investment activities, which are mostly consistent with the proposed regulations previously issued. Investment activities generating UBTI may be aggregated if they qualify as a QPI. To qualify as a QPI, the exempt organization must meet the requirements of the “de minimis test” or “the participation test” (referred to as the “control test” in the proposed regulations). Generally, the exempt organization must directly or indirectly hold no more than 2 percent of the profit interest and no more than 2 percent of the capital interest in a partnership to meet “de minimis”. To meet the participation test, the organization must not hold more than 20% of the capital interest in the partnership, and not have significant participation in the partnership.
The proposed regulations included a “look-through” rule. This rule allowed an organization to treat as a QPI an indirect partnership interest held through a non-QPI (because it directly held more than 20%), so long as the organization did not control the directly held partnership interest. In response to comments, the final regulations expanded the “look-through” rule permitting 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 allow application of the look-through rule to indirectly-held partnership interests that meet the requirements of the participation test with regard to the immediately higher-tier partnership that owns interest in that partnership.
In addition, the regulations clarify that qualifying S Corporation interests and certain debt-financed properties may be treated as investment activities includible with other QPIs in the UBTI calculation.
In response to concern about the “siloing” impact on the public support test, the final regulations allow an exempt organization with more than one trade or business activity to determine its public support using either its “siloed” UBTI or its UBTI calculated in the aggregate under the previous rules. This is to ensure that the new rules do not have an adverse impact on the public support calculation.
The final regulations are applicable to taxable years beginning on or after the date of publication in the Federal Register (or earlier if the exempt organization so chooses). For more information about calculating UBTI for tax-exempt organizations, contact Richard J. Locastro, CPA, JD, Director, Nonprofit Tax at firstname.lastname@example.org or 301-951-9090.
Partner and Director, Nonprofit Tax