The IRS issued proposed regulations Thursday (REG-106864-18) on the new rule that requires tax-exempt organizations subject to tax on unrelated business taxable income (UBTI) to calculate UBTI separately with respect to each business — or to “silo” revenue and expenses for each separate business. The silo rules are found in Sec. 512(a)(6), which was enacted in the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.
Under prior law, UBTI was the gross income of all unrelated trades or businesses less the allowed deductions from all unrelated trades or businesses. Effective for tax years beginning after Dec. 31, 2017, the loss from one trade or business, including any net operating loss (NOL) deduction, may not offset the income from a separate trade or business.
The IRS had issued interim guidance in Notice 2018-67, which permitted taxpayers to identify separate trades or businesses by using the six-digit code used by the North American Industry Classification System (NAICS). In the proposed regulations, however, the IRS, in response to comments, proposed to use the two-digit NAICS code, which designates the sector of economic activity, such as “retail trade” or “accommodation and food services.” By using those broader classifications, the IRS is making it easier for exempt organizations that run businesses to determine which code applies and to administer the rules. The AICPA made recommendations in November 2019 that the IRS and Treasury should allow taxpayers to use a higher level of aggregation in order to separate and classify unrelated trades or businesses.
Once the businesses are broken into separate silos, the organization must determine how to allocate expenses that may apply to more than one activity to each silo. Until the IRS issues further guidance on the issue, the expenses may be allocated using any reasonable method.
The AICPA supports that a tax-exempt organization, in choosing a method for expense allocation, should use the general standard of “reasonable and necessary” and consistently follow the same method from year to year and that the selected method should not result in the double counting of any expenses. The IRS and Treasury are continuing to consider the allocation issue and intend to publish separate proposed regulations providing further guidance on this issue.
Consistent with Notice 2018-67, the proposed regulations provide that an exempt organization’s various investment activities are generally treated as a separate unrelated trade or business. The AICPA had also made previous recommendations supporting the intention that an exempt organization’s investment activities should be treated as a single trade or business.
The proposed regulations specifically list as investment activities that can be treated as one separate unrelated trade or business: (1) qualifying partnership interests (QPIs); (2) debt-financed properties; and (3) qualifying S corporation interests.
The proposed regulations also address how IRAs are treated under these rules, explaining that they are treated as trusts and are subject to the unrelated trade or business rules. Additionally, the proposed regulations provide that inclusions of Subpart F income and global intangible low-taxed income are treated in the same manner as dividends for purposes of Sec. 512.
In addition, the proposed regulations address NOLs. They clarify that the language of Sec. 512(a)(6) and Section 13702(b) of the TCJA do not alter the ordering rules under Sec. 172. Therefore, the proposed regulations provide that an exempt organization with both pre-2018 and post-2017 NOLs will deduct its pre-2018 NOLs from its total UBTI under Sec. 512(a)(6)(B) before deducting any post-2017 NOLs with regard to a separate unrelated trade or business from the UBTI from that unrelated trade or business. The proposed regulations clarify that pre-2018 NOLs are deducted from total UBTI in the manner that results in maximum utilization of the pre-2018 NOLs in a tax year. In its previous comments the AICPA had asked for additional guidance on NOLs and the ordering rules.
Written or electronic comments can be sent until 60 days after April 24, the date these proposed rules are to be published in the Federal Register. The IRS will hold a public hearing if requested. Final regulations will apply to tax years beginning on or after the date they are published as final. For tax years beginning before that date, an exempt organization may rely on a reasonable, good-faith interpretation of Secs. 511 through 514, considering all the facts and circumstances, when identifying separate unrelated trades or businesses for purposes of Sec. 512(a)(6)(A). In addition, for these same tax years, an exempt organization may rely on these proposed regulations in their entirety. Alternatively, for these same tax years, an exempt organization may rely on the methods of aggregating or identifying separate trades or businesses provided in Notice 2018-67.
— Sally P. Schreiber, J.D., (Sally.Schreiber@aicpa-cima.com) is a Tax Adviser senior editor.