The Tax Cuts and Jobs Act (TCJA), Public Law 115-97, signed into law on Dec. 22, 2017 contains a provision, section 512(a)(6), that requires organizations subject to the unrelated business income tax under section 511, with more than one unrelated trade or business, to calculate the unrelated business taxable income (UBTI) separately with respect to each trade or business. The effects of the new law are to prevent the losses of one unrelated trade or business against the income of another unrelated trade or business. The provision did not contain any guidance or definitions concerning what constitutes a “separate trade or business” for purposes of section 516(a)(6). In order to provide guidance to the exempt organization community the IRS has released Notice 2018-67, which provides interim guidance for the application of section 512(a)(6).
Before the enactment of the TCJA, an exempt organization could aggregate all of its UBTI generating activities in arriving at net taxable income. This aggregation permitted the exempt organization losses on one UBTI activity to offset the income on different UBTI activity. For example, an organization with income on its publication advertising activity could use losses generated by its debt-financed rental activity to offset the advertising income. Consequently, the ability to offset the income from one unrelated business activity with the losses of another permitted exempt organizations the ability to lesson or eliminate the overall taxation of the organization’s UBTI activities.
Per Notice 2018-67, for determining the trades or businesses that an exempt organization engages in – other than through a partnership – the use of North American Industry Classification System (NAICS) 6-digit codes to determine whether an exempt organization has more than one unrelated trade or business will be considered a reasonable, good-faith interpretation of section 512(a)(6) on which taxpayers may rely. For example, all of an exempt organization’s advertising activities and related services (NAICS code 541800) might be considered one unrelated trade of business activity, regardless of the source of the advertising income.
Under section 512(c), exempt organizations are required to report the organization’s portion of the unrelated business activities of a partnership as unrelated business income of the exempt organization. In Notice 2018-67 the IRS and the Treasury Department have acknowledged the administrative burden imposed on exemption organizations as result of section 512(a)(6) with respect to the nature of partnership investments and need to report these investments on a separate basis. For exempt organizations investing in partnerships, Notice 2018-67 provides the following interim rules regarding the ability to aggregate the partnership investments for purposes of Form 990-T reporting. An exempt organization may aggregate its UBTI from its interest in a single partnership with multiple trades or businesses (including trades or businesses conducted by lower-tier partnerships) if the interest in the partnership meet one of two tests. The first test is a de minimis test, which the exempt organization meets if it holds directly no more than 2 percent of the profits interest and no more than 2 percent of the capital interest of the partnership. The second test is a control test. For the control test, the exempt organization satisfies this test if it directly holds no more than 20 percent of the capital interest and does not have control or influence over the partnership. Furthermore under the interim rule, an exempt organization is permitted to aggregate all of its partnership interests meeting the de minimis or control test and treat the aggregate group of qualifying partnership interests as comprising a single trade or business for purposes of section 512(a)(6).
As previously acquired partnership interests may not be able to be modified to meet the de minimis test or the control test, if the partnership interest was acquired prior to August 21, 2018, an exempt organization may treat each partnership interest as comprising a single trade or business for purposes of section 512(a)(6). This test is applied regardless of whether it meets the de minimis or control test and regardless of whether or not there is more than one trade or business directly or indirectly conducted by the partnership or lower-tier partnerships.
In Notice 2018-67 the IRS and Treasury Department provide introductory observations regarding amounts included in UBTI under section 512(b)(4) (relating to unrelated debt-financed income), section 512(b)(13) (relating to certain income from controlled entities), and section 512(b)(17) (relating to certain insurance income). Notice 2018-67 states that Treasury and the IRS do not currently see a difference between these categories of UBTI and income derived from an unrelated trade or business for purposes of section 512(a)(6). They state that they recognize that aggregating income included in UBTI under section 512(b)(4), (13), or (17) “may be appropriate in certain circumstances.”
Per Notice 2018-67 Treasury and the IRS have determined that an inclusion of global intangible low-taxed income (GILTI) under section 951A(a) is to be treated as a dividend. A dividend is generally excluded from UBTI under section 512(b)(1).
Any amount included in UBTI under new section 512(a)(7) is not subject to section 512(a)(6) per Notice 2018-67. Section 512(a)(7) increases UBTI by any amount for which a deduction is not allowable under by reason of section 274 for any qualified transportation fringes, parking facility used in connection with qualified parking or any on-premises athletic facility.
The IRS notice requests comments on the aforementioned items. The notice generally provides that until proposed regulations are published, exempt organizations may rely on a reasonable, good-faith interpretation of sections 511 through 514, considering all the facts and circumstances, when determining whether an exempt organization has more than one unrelated trade or business for purposes of section 512(a)(6). The use of NAICS 6-digit codes will be considered a reasonable, good-faith interpretation until regulations are proposed. Furthermore until proposed regulations are published, exempt organizations may rely on the interim rules for aggregating income from partnerships.