Calculating UBI for Separate Businesses Under TCJA

Preliminary Guidance for Calculating UBTI for Separate Businesses Under the TCJA

September 19, 2018

IRC §512(a)(6), effective January 1, 2018, requires an organization to calculate unrelated business taxable income (UBTI) separately for each unrelated trade or business. A net loss for one trade or business will no longer be available to offset a net gain from another trade or business.  Exempt organizations with partnership investments generating UBTI now have guidance regarding what defines a separate trade or business.  

On August 21, 2018, the IRS released Notice 2018-67 providing interim and transition rules for identifying separate trades or businesses under this new code section as well as treatment of global intangible low-taxed income (GILTI) under §951A. Based on this preliminary guidance, we are sharing our understanding of its potential impact. The following is a summary of the key sections of the Notice.

Reasonable, good-faith interpretation  

The IRS and Treasury state that they intend to issue proposed regulations on §512(a)(6), but until such time, exempt organizations may rely on “a reasonable, good-faith interpretation” of Sections 511 through 514 (the code sections pertaining to UBTI) to determine separate trades or businesses. Use of 6-digit NAICS (North American Industry Classification System) codes, already required to be shown on Form 990-T, is mentioned as one factor in making a reasonable, good-faith interpretation. The fragmentation principle in §513(c) and §1.513-1(b), and related guidance, may also be useful in determining trades or businesses.

Partnership investments

A major focus of the Notice is the treatment of partnership investments. Section 4 of the Notice states:

…as a matter of administrative convenience, the Treasury Department and the IRS intend to propose regulations treating certain activities in the nature of an investment (‘investment activities’) of an exempt organization as one trade or business for purposes of §512(a)(6)(A) in order to permit exempt organizations to aggregate gross income and directly connected deductions from all such “investment activities.”

This statement is welcome news and means that, in most cases, the burdensome task of carving up underlying K-1 activities will not be necessary.

That said, Section 6 of the Notice lays out 2 sets of rules[1] (the Interim and Transition Rules) for determining whether a particular partnership investment might go beyond what is described as “investment activities” and for which looking through the partnership to underlying separate trades or businesses might be required. If the partnership investment meets the requirements of either of the 2 rules below, then the partnership investment is treated as a single trade or business and no look-through to underlying activities is necessary.

SEE OUR DECSION TOOL BELOW TO DETERMINE HOW TO TRACK UBTI ACCORDING TO THIS PRELIMINARY GUIDANCE.

New interim and transition rules

The Interim Rule – Until regulations are published, an exempt organization can aggregate the UBTI generated from a single partnership interest with multiple underlying trades or businesses if the directly-held interest in the partnership meets either the de minimis test OR the control test.

1. The de minimis test is met if the exempt organization holds no more than 2% of the profits/capital of the partnership, as reported in Part II, Line J of Schedule K-1.

2. The control test is met if the exempt organization directly holds no more than 20% of the capital interest as reported in Part II, Line J of Schedule K-1 and does not have control or influence over the partnership. 

The exempt organization’s percentages for either test above must include ownership percentages of: disqualified persons, controlled entities under §512(b)(13) and supporting organizations.

The Transition Rule – for a partnership interest acquired prior to August 21, 2018, an exempt organization may treat each such partnership interest as comprising a single trade or business for purposes of §512(a)(6) whether or not there is more than one trade or business directly or indirectly conducted by the partnership or lower-tier partnerships.

A partnership investment meeting either of the Interim Rule Tests is treated as a Qualifying Partnership Interest, requiring no look-through to the partnership’s underlying activities, AND its income/losses can be aggregated with all other Qualifying Partnership Interests.  If a partnership investment meets only the Transition Rule, no look-through to underlying activities is required, BUT it is not considered a Qualifying Partnership Interest. In that case, the organization would default to the more general “reasonable, good-faith determination” standards, i.e. NAICS code, to establish the trade or business to which that partnership’s income/losses correspond.

Other items of note

Unrelated debt-financed income – Any unrelated debt-financed income arising from partnership investments meeting either the Interim or Transition rules can be aggregated with other UBTI arising from that partnership investment.

Transportation benefits UBTI – UBTI from providing qualified transportation benefits to employees under §512(a)(7) is not income from a trade or business for purposes of §512(a)(6).

Global intangible low-taxed income (GILTI) – Some have questioned whether GILTI, a type of subpart F income attributed to US shareholders of a controlled foreign corporation, should be treated as UBTI. The IRS and Treasury conclude in the Notice that “an inclusion of GILTI will be treated as a dividend which is generally excluded from UBTI under Code §512(b)(1).”

The ordering of net operating losses – The TJCA established new rules for net operating losses. For losses incurred after December 31, 2017, the net operating loss deduction for the UBTI of corporations on Form 990-T is limited to 80% of taxable income. There is uncertainty on the ordering of deductions in cases where an organization has either multiple trades/businesses or pre-2018 net operating losses. The IRS is requesting comments on how the net operating loss deduction should be taken with respect to the new rules under §512(a)(6).

Decision Tool to assist Exempt Organizations (EO) track unrelated business income (UBTI) with respect to IRS Notice 2018-67

Does not apply to social clubs described in §501(c)(7) that are subject to §512(a)(3).

[1] Limitations. Per Notice 2018-67, “The interim rule and the transition rule do not apply to exempt organizations described in §501(c)(7) that are subject to §512(a)(3). See section 7 of Notice 2018-67. Furthermore, these rules do not otherwise impact the application of §512(c) and the fragmentation principle under §513(c).”