Unrelated Business Income Taxes (UBIT) | “Trade or Business” (Silo-ing)

On December 22, 2017, President Trump signed into law Public Law No. 115-97 that includes two new provisions regarding unrelated business income tax (“UBIT”). The first provision, Section 512(a)(6), directs nonprofits “with more than 1 unrelated trade or business” to compute their unrelated business income (and related losses) earned “separately with respect to each such trade or business,” but it does not provide any definition about what constitutes a “separate” trade or business, creating uncertainty about how to document, compute, report, and pay such a tax.

Regulations based on prior law provided that, in determining unrelated business taxable income, an organization that operates multiple unrelated trades or businesses could aggregate all revenues and expenses from all such activities and compute UBIT liability on the aggregate income. This permitted an organization to use a loss from one unrelated trade or business to offset income from another, thereby reducing total unrelated business taxable income. Significantly, because income and losses were treated in the aggregate, distinctions between separate businesses were made, if at all, not for tax payment or reporting purposes, but instead largely for internal management and, perhaps, branding purposes.

Why It Matters

The new unrelated business income taxes (UBIT) on nonprofits took effect on January 1, 2018. Nonprofits had only a few days over the holidays to learn of and try to understand these new tax liabilities, adapt their accounting systems and procedures to secure full compliance, and budget for the unanticipated costs. For many organizations, the application of the new liabilities landed in the middle of their fiscal years, thus requiring different cost allocation and tax treatment within the same accounting period, adding to the burden and costs of compliance. Many were required to make quarterly estimated payments to the IRS by mid-April 2018 based on their best guess of what their new tax liabilities might be since no guidance had been issued.

The new Section 512(a)(6) of the Internal Revenue Code changes the way nonprofits calculate UBIT; instead of aggregating all of their profits and losses from unrelated business activities, nonprofits must now "silo" their revenues and expenses for each "separate" "trade or business" and pay UBIT on each. Neither of the quoted terms is defined in the law, causing nonprofits, foundations, accountants, and tax lawyers to demand relief and clarity. The proposed rules released in August 2018 provide some clear answers and instructions on how to comply with the law immediately, but many questions remain that must be resolved during the formal rulemaking process.

Where We Stand

“The charitable nonprofit community has very grave concerns about the implementation of new subsections 512(a)(6) and (7) of the Internal Revenue Code and believes that Treasury and the IRS have a duty to the regulated community to provide immediate relief and substantive guidance on these provisions.”

Updated Comments to Secretary Mnuchin and Commissioner Kautter

Take Action

The Notice provides a way for nonprofits to comply with the new law and the opportunity to recommend changes to the proposed rule that fix any shortcomings. The first step for any nonprofit potentially affected by this tax is to review the NAICS codes and compare your unrelated business revenue streams to determine which categories apply neatly, and which codes don’t make sense. Then call your Representative and Senators at 202-225-3121 and tell them to repeal the siloing provision under the 2017 federal tax law at Section 512(a)(6).

Status

On August 21, 2018, the Treasury Department and Internal Revenue Service have issued a Request for Comments on proposed interim and transition rules (Notice 2018-67) for interpreting one of the two major changes to nonprofit unrelated business income tax (UBIT) included in federal tax law.

In the Notice, Treasury and the IRS acknowledge the frustration and confusion that nonprofits are experiencing, stating: “There is no general statutory or regulatory definition defining what constitutes a ‘trade or business’ for purposes of the Internal Revenue Code.” The Notice expressly provides that starting on January 1, 2018 (when the tax-law provision took effect) until issuance of final regulations (probably in 2019) nonprofits may rely on a reasonable, good faith interpretation of the UBIT statutes in determining whether their organizations have more than one "trade or business." Specifically, the IRS suggested using the North American Industry Classification System (NAICS) 6-digit codes as a reasonable, good faith interpretation. Practically, this means:

• Nonprofits can combine the revenue and expenses from all advertising activities (e.g. online advertising and ads in a variety of print publications) into one category (NAICS code 541800), since these would all be within the same NAICS code.
• But the NAICS code may not provide clarity for some or many other sources of revenue and expenses. For example, the NAICS has multiple codes relating to rentals. Consequently, rental income and expenses may need to be divided or grouped in other ways, meaning it’s possible that expenses for some types of rentals may not be used to offset income from other types.

A separate question arises when a nonprofit has an ownership interest in a partnership that engages in many “trades or businesses.” For now, the IRS will treat revenue from a partnership as a single "trade or business" if one of two tests is satisfied: the de minimis test (ownership interest of no more than 2%) or the control test (no more than 20% ownership interest and no control over the operations of the business). Revenue from other forms of partnership interests that fail to meet these tests can still be treated as a single "trade or business" during the one-year transition period that runs from August 21, 2018 to August 21, 2019.

Representative Conaway(R-TX) introduced the "Nonprofits Support Act" (HR 513), and Senators Cruz (R-TX) and Shaheen (D-NH) introduced the bipartisan bill "Preserve Charities and Houses of Worship Act" (S.1282) to repeal Section 512(a)(6) as well the tax on nonprofit transportation benefits under Section 512(a)(7). Read the press release. 

Resources

• Comments to the IRS Notice 2018-67, National Council of Nonprofits, December 3, 2018.
• Unrelated Business Income Taxation, National Council of Nonprofits
• Resources on How the New Federal Tax Law Impacts Charitable Nonprofits, National Council of Nonprofits
• Request for Comments Regarding the Calculation of Unrelated Business Taxable Income under sec. 512(a)(6) for Exempt Organizations with More than One Unrelated Trade or Business, Internal Revenue Service, August 21, 2018.
• Updated Letter to IRS/Treasury requesting delay in implementation of the new UBIT provisions in Public Law No. 115-97, National Council of Nonprofits, July 21, 2018.
• Preliminary Letter to IRS/Treasury requesting delay in implementation of the new UBIT provisions in Public Law 115-97, National Council of Nonprofits, April 24, 2018.
• Guidance Released for UBIT Reporting by Activity, BKD, September 6, 2018.
• Unrelated Business Tax Regs May Bring Nonprofits Headaches, National Council of Nonprofits, August 22, 2018.
• IRS Issues Guidance for New UBTI “Siloing” Rules under Section 512(a)(6), Quarles & Brady LLP, August 29, 2018.
• Letter to the Members of Congress, Council on Foundations, July 11, 2018.
• Comments on the regulatory implementation of new section 512(a)(6), American Bar Association - Section of Taxation, June 21, 2018.
• Request for Immediate Guidance and Delay, National Association of Independent Schools, June 7, 2018.
• Request for Delay in Effective Date of IRC Section 512(a)(6), AICPA, April 17, 2018.
• Joint Explanatory Statement of the Committee of Conference, at pages 410-411, U.S. Congress