What has changed and how
Recently, the Internal Revenue Service (IRS) proposed new unrelated business taxable income (UBTI) reporting guidance. The guidance is meant to provide direction on how a tax-exempt organization subject to UBTI determines if it has more than one unrelated trade or business, and if so, how the tax-exempt organization calculates UBTI under section 512(a)(6).
Prior to the Tax Cuts and Jobs Act, an exempt organization engaging in two or more unrelated trades or businesses aggregated the gross income from all the unrelated trades or businesses, and reduced that amount by the aggregated deductions allowed to compute the organization's UBTI.
Now, section 512(a)(6) requires that the organization’s UBTI for the taxable year is the sum of the amounts (not less than zero) computed for each separate trade or business, less the specific deduction allowed under section 512(b)(12).
Section 512(a)(6) continues to allow a net operating loss (NOL) deduction, but only with respect to a trade or business from which the loss arose. The legislative history states “a deduction from one trade or business for a taxable year may not be used to offset income from a different unrelated trade or business for the same taxable year.” Because section 512(a)(6) disallows the aggregation of income and deductions from all unrelated trades or businesses, these proposed regulations revise section 1.512(a)-1(a) to state that, in the case of an organization with more than one unrelated trade or business, UBTI is calculated separately with respect to each such trade or business, as provided in new proposed section 1.512(a)-6.
Proposed Regulation section 1.512(a)-6(h)(2) explains that an organization with losses arising in a taxable year beginning before Jan. 1, 2018 (pre-2018 NOLs), and with losses arising in a taxable year beginning after Dec. 31, 2017 (post-2017 NOLs), deducts its pre-2018 NOLs from total UBTI before deducting any post-2017 NOLs with regard to a separate unrelated trade or business against the UBTI from such separate trade or business. Pre-2018 NOLs are taken against the total UBTI as determined under paragraph (g) of this section in the manner that results in maximum utilization of the pre-2018 NOLs in a taxable year.
How to identify each unrelated trade or business
There is no general statutory or regulatory definition of what activities constitute a “trade or business” for purposes of the Internal Revenue Code.
Proposed Regulation section 1.512(a)-6(b) provides, in general, an exempt organization would identify each of its separate unrelated trades or businesses using the first two digits of the North American Industry Classification System (NAICS) code that most accurately describes a trade or business. The proposed regulations also provide how an organization will allocate deductions between the separate trades or businesses.
The proposed regulations explain that:
- Allowing the use of NAICS two-digit codes to identify separate unrelated trades or businesses reduces the compliance costs of affected organizations relative to the use of NAICS six-digit codes. For example, different types of food services would be in the same NAICS two-digit code as opposed to separate NAICS six-digit codes. Similarly, different types of recreational activities, such as fitness centers and golf courses, would be in the same NAICS two-digit code as opposed to separate NAICS six-digit codes.
- However, a college or university described in section 501(c)(3) cannot use the NAICS two-digit code for educational services to identify all its separate unrelated trades or businesses, and a qualified retirement plan described in section 401(a) cannot use the NAICS two-digit code for finance and insurance to identify all of its unrelated trades or businesses.
Meeting the public support test
The Treasury Department and the IRS are not aware of any intent of Congress to change the public support test when enacting section 512(a)(6). Thus, the proposed regulations include revisions to sections 1.170A-9(f) and 1.509(a)-3 to permit an organization with more than one unrelated trade or business to aggregate its net income and net losses from all of its unrelated business activities, including its unrelated trades or businesses within the meaning of section 512, for purposes of determining whether the organization is publicly supported.
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
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