By Pension and Benefits Editorial Staff
Proposed regulations providing guidance on how a tax-exempt organization with more than one unrelated trade or business should identify its separate trades and businesses, and on how to separately calculate their unrelated business taxable income (UBTI) for each trade or business - often referred to as a “silo” - have been released by the IRS. The proposed regulations also clarify the definition of UBTI for individual retirement accounts (IRAs).
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(a)(1) imposes a tax on the UBTI of organizations described in Code Sec. 511(a)(2), which includes organizations described in Code Secs. 401(a) and 501(c). Since 2018, under provisions of the Tax Cuts and Jobs Act (TCJA), the loss from one unrelated trade or business may not offset the income from another, separate trade or business. Congress did not provide detailed methods of determining when unrelated businesses are “separate” for purposes of calculating UBTI.
Method of determining separate trades or businesses. The IRS has considered using the North American Industry Classification System (NAICS) six-digit codes for determining what constitutes separate trades or businesses for this purpose. IRS Notice 2018-67 permitted reliance on these codes by tax-exempt organizations. However, since these codes were not developed for purposes of the tax on unrelated business, there was concern that they are too detailed and, therefore, the specific choices available to exempt organizations too subjective.
The first two digits of the code designate the economic sector of the business. The proposed regulations provide that organizations will be able to utilize just the first two digits of the code, which divides businesses into 20 categories, for this purpose.
Clarifications for benefit plans. Code Sec. 512 contains two separate definitions of UBTI. The definition in Code Sec. 512(a)(1) applies generally, while the definition in Code Sec. 512(a)(3) applies only to social clubs under Code Sec. 501(c)(7), voluntary employee’s beneficiary associations (VEBAs) under Code Sec. 501(c)(9), and supplemental unemployment compensation benefit (SUB) trusts under Code Sec. 501(c)(17). However, qualified retirement plan trusts under Code Sec. 401(a) and SUBs define unrelated trade or business under Code Sec. 513(b).
Notice 2018-67 stated in a footnote that, because IRAs described in Code Sec. 408 are, under Code Sec. 408(e), subject to the tax imposed by Code Sec. 511, and IRAs are most similar to qualified retirement plans, it is reasonable to apply the definition of “unrelated trade or business” described in Code Sec. 513(b) to IRAs. The IRS stated that it intended to provide that the Code Sec. 513(b) definition of unrelated trade or business should be used for IRAs that are subject to the unrelated business income tax in Code Sec. 511 pursuant to Code Sec. 408(e). Thus, the proposed regulations clarify this issue by providing that IRAs described in Code Sec. 408(e) use the definition of unrelated trade or business applicable to trusts and described in Code Sec. 513(b).
ESOPs. The IRS also discussed the interaction of UBTI rules and employee stock ownership plans (ESOPs). Although Code Sec. 512(e) generally does not apply to S corporation ESOPs, the application of Code Sec. 409(p) to an S corporation ESOP might give rise to UBTI. The primary means of avoiding a Code Sec. 409(p) failure is for the S corporation ESOP to transfer some of its S corporation shares to a non-ESOP portion of the plan or to another qualified retirement plan of the employer. The transferred shares, no longer held in an ESOP, are not described in Code Sec. 512(e)(3). Accordingly, the transferee plan treats the S corporation interest resulting from the transfer of the S corporation shares as an interest in an unrelated trade or business under the general rule of Code Sec. 512(e)(1). The IRS anticipates that a transferee plan is not likely to have more than one S corporation interest. However, whether this S corporation interest may be aggregated with the investment activities of the transferee plan will depend on whether the S corporation interest is a qualifying S corporation interest. The IRS requests comments on this issue.
Comments requested. Written or electronic comments and requests for a public hearing must be submitted by June 23, 2020. Send hard copy submissions to: CC:PA:LPD:PR (REG-106864-18), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submit electronic submissions via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-106864-18).
Source: IRS proposed regulations, 85 FR 23172.
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