UBTI of private clubs altered by long-awaited guidance

May 26, 2020
Private clubs Business tax Indirect tax

Over the past few months, it seems the world has been turned upside down, and private clubs have not been immune to the turmoil. Across the country, there are empty clubhouses, locker rooms, pro shops and dining facilities. Much of the focus lately has been on loan programs (who qualify and who doesn’t), new credits, and other forms of stimulus that might help clubs retain employees and pull through the COVID-19 pandemic. In the flurry of that activity, the Treasury and IRS released proposed regulations (REG-106864-18) under section 512(a)(6), which provide long-awaited guidance on computing unrelated business taxable income (UBTI) that likely will affect most tax-exempt private clubs.


The 2017 tax law (Pub. L. 115-97) added code section 512(a)(6), which requires exempt organizations (including tax-exempt clubs) with more than one unrelated trade or business to calculate UBTI separately for each trade or business, effectively limiting losses to the unrelated trade or business that generates them. In August 2018, the IRS issued Notice 2018-67, permitting a reasonable, good faith interpretation of sections 511 through 514 and providing interim guidance on the application of section 512(a)(6), including using six-digit North American Industry Standard Classification System (NAICS) codes to determine separate unrelated trades or businesses.

Interpreting the guidance offered by the Notice, many tax-exempt private clubs aggregated the income and expenses associated with many of their unrelated activities under “golf courses and country clubs” (NAICS code 713910).


The proposed regulations retain the general framework set forth in Notice 2018-67 while making numerous modifications in an effort to reduce the burden imposed on exempt organizations in separately computing UBTI. The proposed regulations also address a number of questions left unanswered by the Notice.

While retaining the use of NAICS codes, the proposed regulations generally require the use of two-digit NAICS codes. Although this guidance reduces the possible number of separate trades or businesses from over a thousand to 20, the proposed regulations also provided a clarification for purposes of determining the proper NAICS code. Specifically, the proposed regulations require an organization to utilize the two-digit NAICS code that most accurately describes the unrelated trade or business, not the exempt purpose activities.

Accordingly, and as described in the preamble to the proposed regulations, a social club may not categorize all of its unrelated trades or businesses as “arts, entertainment and recreation” (NAICS code 71). Instead, a social club must determine the code best aligned with each activity. Although green fees paid by nonmembers may properly belong in NAICS code 71, merchandise sales and food and beverage services likely fit under a different two-digit NAICS code.

In the case of many tax-exempt social clubs, there might be three typical unrelated trades or businesses:

  • Pro shop sales (NAICS code 45)
  • Food and beverage services (NAICS code 72)
  • Green fees (NAICS code 71)

However, there can be more than these three.

Investment income

The proposed regulations also address investment activities in significant detail and generally provide that an exempt organization’s investment activities (as specifically defined) are treated collectively as one separate trade or business. For these purposes, they are tax-exempt clubs aggregate debt-financed income, interest, dividends, annuities, royalties, rents from real property, and capital gains or losses as investment activities.1 In aggregating these sources of income, tax-exempt clubs must pay special attention to the definition of “rents from real property” because not all facility rental income meets this definition.

Expense allocation

Allocating administrative and other indirect expenses between related and unrelated income always poses a challenge with existing guidance permitting any reasonable method of allocation. Examples of indirect expenditures may include overhead costs, salaries and wages, and other expenses allocated among various lines of trade or business. With the requirement to separately compute UBTI for each unrelated trade or business, the allocation issue becomes even more pronounced. Nevertheless, the proposed regulations do not provide specific guidance or safe harbor with respect to what constitutes a reasonable expense allocation method. Treasury and the IRS intend to release additional guidance in the future.

Private clubs commonly use a gross-to-gross method to allocate indirect expenses to unrelated trades or businesses. This method divides the gross income generated by an unrelated trade or business by the gross income of that overall activity (e.g., nonmember pro shop sales divided by all pro shop sales). The resulting percentage is then applied to the indirect expenses to determine the deduction against UBTI. If the pricing differs between the unrelated (i.e., nonmember) and related (i.e., member) activities, but the cost of providing the goods or services is the same, this would result in an unadjusted gross-to-gross method. The proposed regulations provide that the unadjusted gross-to-gross method is not reasonable because the gross-to-gross ratio is inflated, resulting in a disproportionate amount of indirect expenses being allocated to the unrelated activity.

To appropriately account for this disparity, the proposed regulations require that the organization adjusts the per unit price of the goods or service of the related activity to match that of the unrelated activity before calculating the expense allocation ratio. This pricing practice is most common in club pro shops, but it may also exist in other areas, such as the restaurant’s menu pricing or the golf course green fees.

Net operating losses (NOLs)

As a result of section 512(a)(6), some tax-exempt clubs may find themselves in a taxable position for the first time, where they historically generated NOLs.

The proposed regulations provide that an exempt organization should deduct its pre-2018 NOLs before deducting its post-2017 NOLs in a manner that first maximizes the use of the pre-2018 NOLs. However, the proposed regulations do not provide any guidance with respect to the application of NOL carryback rules recently instituted by the Coronavirus Aid, Relief and Economic Security Act. Additional guidance is expected to be issued separately. In the interim, private clubs should track their NOLs to preserve the ability to offset against future income.


The proposed regulations are expected to be effective for taxable years beginning on or after the date they are published as final in the Federal Register. However, taxpayers may rely upon the proposed regulations in their entirety before that time. Alternatively, taxpayers may continue to rely on Notice 2018-67 for purposes of aggregating or identifying separate trades or businesses until final regulations are published. Finally, exempt organizations may rely on a reasonable, good faith interpretation of sections 511 through 514, considering all the facts and circumstances, when identifying separate trades or businesses for purposes of section 512(a)(6)(A).

1 Pursuant to the definition of these terms in section 512(b)(1)-(5).

RSM contributors

  • Frank Lucas
  • Chris Cecil
    Private Clubs Tax Leader
  • Alexandra O. Mitchell

Subscribe to eClub News

Get information and insights that address the unique concerns of private clubs.