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Nonprofit UBTI Tax: Separating Trades or Businesses

The 2017 Tax Cuts and Jobs Act (TCJA) established § 512(a)(6), which requires any exempt organization with more than one unrelated trade or business to calculate unrelated business taxable income (UBTI) separately with respect to each such trade or business. In enacting § 512(a)(6), Congress did not provide criteria for determining how to identify separate unrelated trades or businesses for purposes of calculating UBTI. On August 21, 2018, the IRS released Notice 2018-67 to provide interim guidance and solicit comments for various issues surrounding the special rules that were created under the TCJA for organizations with more than one unrelated trade or business.

Identifying Separate Trades or Business

According to Notice 2018-67, exempt organizations may rely on a reasonable, good faith interpretation of §§ 511-514, considering all the facts and circumstances, when determining whether an exempt organization has more than one unrelated trade or business. The notice mentions a that reasonable, good-faith interpretation includes using the North American Industry Classification System (NAICS) 6-digit codes and the fragmentation principle.

The IRS considers NAICS codes an administrable method for identifying a separate unrelated trade or business. Exempt organizations filing Form 990-T already are required to use the 6-digit NAICS codes when describing the organization’s unrelated trades or businesses. Under a NAICS 6-digit code, all of an exempt organization’s advertising activities and related services (NAICS code 541800) might be considered one unrelated trade or business activity, regardless of the source of the advertising income.

Moreover, the fragmentation principle provides an analysis of each fragment of the tax-exempt organization’s revenue-generating activities to determine whether each separate activity is related or unrelated to the organization’s exempt purpose. For example, activities of soliciting, selling, and publishing commercial advertising do not lose their statuses as trades or businesses even though the advertising is published in an exempt organization periodical that contains editorial matter related to the exempt purposes of the organization.

Allocation of Directly Connected Deductions

To the extent that an exempt organization may have items of deduction that are shared between an exempt activity and an unrelated trade or business, the Treasury regulations § 1.512(a)-1(c) and (d) provide special rules for allocating such expenses. For example, if facilities are used both to carry on exempt activities and to conduct unrelated trade or business activities, then expenses, depreciation, and similar items attributable to such facilities must be allocated between the two uses on a reasonable basis.

Partnership Investments

Notice 2018-67 established an interim rule that allows exempt organizations (excluding social clubs, voluntary employees’ beneficiary associations, and other organizations described in § 501(c)(7)) to aggregate UBTI 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 the:

De minimis test: exempt organization holds directly no more than 2% of the profits interest and no more than 2% of the capital interest; or the

Control test: exempt organization (i) directly holds no more than 20 percent of the capital interest; and (ii) does not have control or influence over the partnership.

Fortunately, the IRS has acknowledged the costliness of this interim rule for organizations with a previously acquired partnership interest and has permitted such organizations to treat each partnership interest acquired prior to August 21, 2018 as comprising a single trade or business for purposes of § 512(a)(6).

Effect of § 512(a)(6) on fringe benefits

Under the TCJA, the definition of UBTI was expanded to include qualified transportation fringe benefits, qualified parking benefits, and on-premises athletic facility benefits. According to Notice 2018-67, such benefits are not a separate trade or business of the exempt organization. This means that organizations engaged in more than one unrelated trade or business can net their parking and transportation expenses against any other UBIT income as of January 1, 2018.

Calculating net operating losses (NOLs) within the framework of § 512(a)(6)

According to Notice 2018-67, NOLs must be calculated separately with respect to each trade or business for taxable years beginning January 1, 2018. Thankfully, under a transition rule created by Congress, NOLs from tax years prior to 2018 are permitted to be taken against total UBTI. Post-2017 NOLs will be calculated and taken before pre-2018 NOLs, because the UBTI with respect to each separate trade or business is calculated under § 512(a)(6)(A) before calculating total UBTI under § 512(a)(6)(B).

Notice 2018-67 also provided interim guidance for the treatment of unrelated debt-financed income, specified payments from controlled entities, and certain insurance income; special rules applicable to social clubs, voluntary employees’ beneficiary associations (VEBAs), and supplemental unemployment compensation benefits trusts (SUBs); and the treatment of global intangible low-taxed income. This interim guidance can be relied on for taxable years beginning after December 31, 2017.

For more information, see IRS Notice 2018-67 or please contact Cherie Williams at or 844.4WINDES.

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