Unrelated business taxable income and club taxation
INSIGHT ARTICLE |
The Tax Cuts and Jobs Act (TCJA) enacted the most comprehensive change in the federal tax code in over three decades. By now, you have probably heard about the changes affecting your personal return, or seen headlines about the reduction in the corporate tax rate. What you probably haven’t seen or heard is a new provision in section 512(a)(6) which could change the way exempt organizations calculate unrelated business taxable income (UBTI). Since many clubs file for tax-exempt status, this provision and how the IRS interprets it, could have a direct impact on the taxation of the UBTI activities of exempt clubs.
Under the old tax law, a club was permitted to aggregate results of all of its trade or business UBTI to arrive at their UBTI. The aggregation allowed clubs to use losses from one UBTI activity to offset gain from another UBTI activity. For example, a club could use losses from their nonmember food and beverage operation to offset gain from nonmember golf. As a result, most clubs arrived at a loss when calculating UBTI. The provision in the new law requires exempt organizations with more than one trade or business that produces UBTI to calculate their UBTI separately for each trade or business. The new law could prevent clubs from using losses from one trade or business activity to offset gain from another unrelated trade or business activity.
While the separate trade or business activity provision in 512(a)(6) became law when the TCJA was signed, the law didn’t provide guidance on what constitutes a separate trade or business. In order to provide interim guidance, the IRS recently released Notice 2018-67 providing provisional guidance on the application section 512(a)(6). Per Notice 2018-67, “the Treasury Department and the IRS are considering the use of North American Industry Classification System (NAICS) codes. Prior to proposed regulations, the Treasury Department and the IRS will consider the use of NAICS 6-digit codes to be a reasonable, good-faith interpretation under section 3.02 of this notice.” The use of NAICS codes to determine separate trade or businesses could be good news for clubs as the code for golf courses and country clubs (713910) encompasses the operation of the golf course, dining facilities and other recreational facilities, meaning the club will not need to separate each operation for UBTI purposes. However, as is the case and many times dealing with the IRS, the answer is not always black and white. While the notice states the NAICS codes can be used as a reasonable interpretation on how to identify separate trades or businesses, it also goes on to provide an example of a social club having income from multiple sources. The example covers a social club subject to the requirements of section 512(a)(6) as a result of having a dining facility as well as a retail store.
Due to some ambiguity in Notice 2018-67, we will have to wait for further guidance for an exact interpretation on separating trade and businesses. The IRS recognizes that social clubs are taxed differently than other exempt organizations and are in the process of requesting comments for additional considerations that should be given to how section 512(a)(6) should be applied to the social and country club community.