Proposed regulations released on separately computing UBTI

Apr 23, 2020
Apr 23, 2020
0 min. read

On April 23, 2020, the Treasury Department and IRS released proposed regulations (REG-106864-18) under section 512(a)(6), providing exempt organizations with guidance on how to compute unrelated trade or business income (UBTI) for separate trades or businesses. These regulations modify and expand upon preliminary guidance issued on Aug. 21, 2018 in Notice 2018-67.


The 2017 tax law (Pub. L. 115-97) added code section 512(a)(6), which requires an exempt organization with more than one unrelated trade or business to compute UBTI separately with respect to each trade or business, effectively limiting losses to the unrelated trade or business that generates them. Notice 2018-67 provided interim guidance to exempt organizations:

  • Categorize unrelated trades or businesses based upon their six-digit North American Industry Standard Classification System (NAICS) code
  • Aggregate partnership investments that met the de minimis or control tests
  • Provide a transition rule for partnership interests acquired before Aug. 21, 2018


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. 

The issues covered by the proposed regulations generally fall into one of the following categories: 

NAICS codes

The proposed regulations generally require exempt organizations to use two-digit NAICS codes to determine whether they have more than one unrelated trade or business. Exempt organizations will then categorize each unrelated trade or business to these NAICS codes to separately compute UBTI. 

Investment activity

The proposed regulations provide that an exempt organization’s investment activities are treated collectively as a separate trade or business. Investment activities are limited to qualifying partnership interests (QPIs), qualifying S corporation interests, and debt financed property, subject to few specified exceptions.

QPIs are partnership interests that meet either the de minimis or control tests:

  • The de minimis test requires the exempt organization to own not more than 2% of the profits interest and not more than 2% of the capital interest. This test is also available to certain indirectly-held partnerships by virtue of a new look-through rule.
  • The control test requires the exempt organization to own not more than 20% of the capital interest and to not control the partnership. Control is determined based on all facts and circumstances, including the partnership agreement, and there are four enumerated ways in which an exempt organization is deemed to control the partnership (either through powers exercised by the exempt organization or activities of officers, directors, trustees, or employees of the exempt organization). 

In determining ownership, an exempt organization must aggregate the interests of its supporting organizations and section 512(b)(13) controlled organizations.

An exempt organization may continue to rely on the transition rule provided by Notice 2018-67 until the first day of its taxable year following the publication of final regulations. However, the transition and the look-through rules, mentioned above, are mutually exclusive. Any income aggregated under the transition rule is treated as a separate trade or business and is not aggregated with other investment activity.

Exempt organizations that compute UBTI under section 512(a)(3) (i.e., social clubs, VEBAs, and SUBs) may include interest, dividends, annuities, royalties, rents from real property, and capital gains or losses in their investment activities. However, social clubs are ineligible for QPIs and the transition rule in computing investment activities

Controlled organizations

An exempt organization with UBI from controlled entities under section 512(b)(13) must treat as a separate trade or business all payments received from each controlled entity, regardless of whether the controlled entity engages in more than one unrelated trade or business. If the controlling organization receives specified payments from more than one controlled entity, the payments from each controlled entity are treated as a separate trade or business. 

In addition, all income from controlled foreign corporation insurance activities under section 512(b)(17) is treated as a single trade or business. However, this income may not be aggregated with other directly conducted commercial insurance activities.

Net operating losses (NOL)

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 (the CARES Act). Additional guidance is expected to be issued separately. 

S corporations

In general, the proposed regulations provide that each S corporation investment is considered a separate trade or business, unless it is considered a qualifying S corporation, in which case it may be aggregated with other investment activities. A qualifying S corporation investment is one that meets the definition of a QPI, based on the organization’s percentage of stock ownership. 


The proposed regulations also highlight a number of other issues affected by the requirement to separately compute UBTI for each unrelated trade or business:

  • The public support test – in computing their public support, public charities should include UBTI without application of section 512(a)(6);
  • Subpart F income and GILTI – both amounts are treated in the same manner as dividends for purposes of computing UBTI;
  • Unadjusted gross-to-gross method – in allocating indirect expenses to unrelated trades or businesses, using an unadjusted gross-to-gross method is unreasonable; and
  • Definition of unrelated trade or business for trusts – any trade or business regularly carried on by a trust (i.e., for purposes of section 681, 401(a), 408, or 501(c)(17)) or by a partnership of which it is a member.

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 prior to 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).

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