On August 21, the Internal Revenue Service released IRS Notice 2018-67, which provides long-awaited interim guidance on the new rules under Section 512(a)(6) of the Internal Revenue Code. This IRC section, added by the Tax Cuts and Jobs Act, requires an exempt organization with more than one unrelated trade or business to separately calculate unrelated business taxable income (UBTI) with respect to each trade or business.
Until proposed regulations are released later this year, exempt organizations can rely on this interim guidance. Following are some observations on what’s provided in the IRS Notice.
Multiple Unrelated Trade or Business Activities
There is no statutory or regulatory definition as to what constitutes a trade or business for UBTI purposes. Pending issuance of proposed regulations, exempt organizations may rely on reasonable, good-faith interpretations of the IRC, including all facts and circumstances, when determining whether it has more than one trade or business. Use of the NAICS 6-digit codes will be considered a practical interpretation until proposed regulations are published.
Investments in Partnerships with UBTI
Exempt organizations other than social clubs (IRC Section501(c)(7)) may aggregate UBTI from an interest in a single partnership with multiple trades or businesses conducted by lower-tier partnerships, as long as the directly held interest in the partnerships meets the requirements of either the de minimis test or the control test. Additionally, under the interim rule, an exempt organization may aggregate all qualifying partnerships interests and treat the group of qualifying partnership interests as comprising a single trade or business for purposes of IRC 512(a)(6)(A). The income from qualifying partnership interests that may be aggregated includes debt-financed income.
In general, the de minimis test is met if the exempt organization directly holds no more than 2% of the profits interest and no more than 2% of the capital interest. Generally the control test is met if the organization’s partnership interest is no more than 20% of the capital interest and the organization does not have control or influence over the partnership. Special rules apply for both tests that require combining related interests in certain circumstances. When determining the percentage interests, an exempt organization may rely on the Schedule K-1 from the partnership.
A transition rule may be applied for a partnership interest acquired before August 21, 2018 if the partnership interest cannot satisfy either the de minimis test or control test. That is, the exempt organization may treat each partnership interest as a single trade or business regardless of whether or not there is more than one trade or business directly conducted by the partnership or lower-tier partnerships.
Other interim guidance in Notice 2018-67 includes the following:
The Notice provides IRS commentary regarding the application of IRC 512(a)(6) to net operating losses, both pre-2018 and post-2017, and requests comments regarding how the NOL should be taken by organizations with multiple trades or businesses, as well as comments on the ordering of NOLs.
Any amount included in UBTI under the newly added IRC Section 512(a)(7) related to certain transportation fringe benefits is not subject to the separate UBTI computation under IRC Section 512(a)(6) because IRC Section 512(a)(7) does not treat these amounts as gross income derived from an unrelated trade or business.
Global intangible low-taxed income (GILTI) should be calculated in the same manner as Subpart F income. That is, the GILTI income is treated as a dividend and subject to the UBTI rules that address dividends.
The IRS and Treasury Department found no clear distinction between income from an unrelated trade or business and that from debt-financed income under IRC 512(b)(4), certain income from controlled entities under IRC 512(b)(13), or certain insurance income under IRC 512(b)(17). Hence, debt-financed income, income from controlled entities and/or certain insurance income may be aggregated when applying IRC Section 512(a)(6) in certain circumstances.
The IRS is soliciting comments on the proposed regulations. Submissions should be offered on or before December 3, 2018.
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