By Pension and Benefits Editorial Staff
The IRS has released interim guidance and transition rules regarding the special rule requiring exempt organizations that have unrelated business taxable income (UBTI) from operating more than one unrelated business to calculate the unrelated business taxable income of each trade or business separately and without regard to the specific deduction of $1,000.
Background. Under Code Sec. 501(a), organizations described in Code Secs. 401(a) and 501(c) generally are exempt from federal income taxation. However, Code Sec. 511 imposes a tax on the UBTI of organizations, including those described in Code Secs. 401(a)and 501(c) as well as individual retirement accounts (IRAs). These entities are collectively called “exempt organizations” in the IRS guidance.
In the case of a trust that is exempt from tax under Code Sec. 501(a) and described in Code Sec. 401(a) (qualified retirement plans) or Code Sec. 501(c)(17) (supplemental unemployment compensation benefits trusts (SUBs)), Code Sec. 513(b) defines “unrelated trade or business,” as any trade or business regularly carried on by such trust or by a partnership of which it is a member.
The Tax Cuts and Jobs Act (P.L. 115-97) added Code Sec. 512(a)(6) to prevent a deduction for one unrelated trade or business from offsetting income from another unrelated business in the same tax year, and to prevent the specific $1,000 deduction from being claimed more than once in a tax year regardless of how many unrelated businesses an exempt organization may have. When separately calculating each unrelated business' income, the UBTI of any particular trade or business cannot be less than zero.
In enacting Code Sec. 512(a)(6), Congress did not provide criteria for determining whether an exempt organization has more than one unrelated trade or business or how to identify separate unrelated trades or businesses for purposes of calculating UBTI. The IRS intends to propose regulations for determining whether an exempt organization has more than one unrelated trade or business for purposes of Code Sec. 512(a)(6) and how to identify separate trades or businesses for purposes of calculating UBTI under Code Sec. 512(a)(6)(A).
Reliance. For taxable years beginning after December 31, 2017, exempt organizations may rely on methods of aggregating or identifying separate trades or businesses under Code Sec. 512(a)(6) provided in this guidance until proposed regulations are published. Organizations may rely on reasonable, good-faith interpretations of Code Secs. 511 through 514 when determining whether an exempt organization has more than one unrelated business for purposes of Code Sec. 512(a)(6), including whether to separate:
- debt-financed income described in Code Secs. 512(b)(4) and 514;
- income from a controlled entity described in Code Sec. 512(b)(13); or
- insurance income earned through a controlled foreign corporation as described in Code Sec. 512(b)(17).
Reliance on the use of NAICS 6-digit codes will be considered a reasonable, good-faith interpretation until proposed regulations are published.
Aggregating income from partnership interests. Exempt organizations, other than social clubs exempt under Code Sec. 501(c)(7), may also rely on the rules provided for aggregating income from partnerships, including any unrelated debt-financed income that is earned through a partnership that meets certain requirements. An exempt organization may aggregate its unrelated business taxable income from its interest in a single partnership with multiple trades or businesses as long as the directly-held interest in the partnership meets the requirements of either a de minimis or a control test.
The de minimis test is met if the exempt organization holds directly no more than two percent of the profits interest and no more than two percent of the capital interest. The organization may rely on the information it receives on its Schedule K-1 in making this determination.
The control test is met if the organization's partnership interest is:
- not more than 20% of the capital interest, and
- the organization has control or influence over the partnership, as determined by all of the facts and circumstances.
Again, reliance on the information on its Schedule K-1 is permitted. A transition rule is provided allowing for aggregating income within each direct partnership interest acquired before August 21, 2018.
Other points of reliance. Other items of guidance on which taxpayers may rely include:
- The nondeductible amount of certain fringe benefit expenses paid or incurred by an exempt organization, as described in Code Sec. 512(a)(7), is not income from a trade or business for purposes of Code Sec. 512(a)(6). Unlike the other subsections of Code Sec. 512, Code Sec. 512(a)(7) does not treat amounts added to unrelated business taxable income as a result of that subsection as gross income derived from an unrelated trade or business.
- When calculating unrelated business taxable income, any global intangible low-taxed income is included under Code Sec. 951A(a) in the same manner as Subpart F income is included under Code Sec. 951(a)(1)(A). It is, therefore, treated as a dividend, and treated in the same manner as other dividends are treated for purposes of Code Sec. 511 under Code Secs. 512(b)(1) and (b)(4).
Other guidance. In addition to the items discussed above on which exempt organizations may rely until proposed regulations are published, guidance is also provided regarding:
- how to calculate net operating losses for purposes of Code Sec. 512(a)(6); and
- special rules for the treatment of exempt function income to organizations described in Code Sec. 512(b)(4), (13), and (17) (i.e. social clubs, voluntary employees' beneficiary associations, and supplemental unemployment compensation benefits trusts).
Comments requested. The IRS has requested comments regarding the various issues and approaches discussed in this guidance, and regarding the application of Code Sec. 512(a)(6) to exempt organizations with more than one unrelated trade or business generally. Comments should be submitted on or before December 3, 2018 to Internal Revenue Service, CC:PA:LPD:PR (Notice 2018-67), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may also be sent electronically to the following e-mail address: [email protected] Submissions should include “Notice 2018-67” in the subject line.
Source: IRS Notice 2018-67.
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