Unrelated Business Income Baskets: New IRS Regulations
Originally published on March 20, 2019
Updated on August 17th, 2022
If your organization has revenues and losses from unrelated business income (UBI), your tax picture could change drastically under the new tax laws.
Starting with tax years beginning after Dec. 31, 2017, organizations with more than one unrelated trade or business must now compute the unrelated business taxable income (UBTI) separately for each income channel, or “basket.” Previously, you could combine income and/or losses from one activity to income/losses from activities in any other basket.
As a result of the new tax law, a loss from one activity can no longer offset income from another to reduce your tax liability on that income. Such a loss will still generate a usable net operating loss (NOL), but you will have to apply it to revenue in that same basket in a future year.
Additionally, NOLs can now only cover up to 80% of the income to which they are applied. However, there is no longer a time limit to using NOLs for this purpose (under the old rules, this had to be done within 20 years from the date they were generated). For example:
- Year 1: Your organization has a net UBI loss of -$10,000 (post-2018 net operating loss).
- Year 2: Your organization has a net UBI income of $5,000 for the same activities.
- You can apply $4,000 of Year 1’s net operating loss to Year 2, because that covers 80% of Year 2’s $5,000 in revenues.
- This results in $1,000 of taxable net UBI for Year 2.
As you can see, you can still use NOLs to reduce your tax liability. However, you need to be aware of the new restrictions.
No, they’re not the latest characters in the Marvel universe. But they are a potential savior when it comes to UBTI.
While an NOL from one activity can no longer be applied to activities in any other basket, NOLs generated before this rule took effect are not subject to that requirement. These NOLs are now referred to as “supercharged” and can still be applied to any basket. Following previous IRS regulations, they are good for 20 years from the year they were generated.
How should I segregate my unrelated business activities?
The IRS states that you may “rely on a reasonable, good-faith interpretation” of the code to determine how you categorize your UBI. The agency has also suggested using the NAICS six-digit codes as a possible reasonable method until final guidance is provided. However, with over 1,000 NAICS codes to potentially choose from, many feel this proposed method could cause inconsistent reporting between organizations (as well as increase an organization’s tax risk).
How does this affect my organization?
This change could have a huge impact on the tax liability for organizations with a wide range of unrelated business activities. If some of these activities earn a lot of income while others experience regular losses, your use of NOLs—a critical tool in your tax strategy—will be significantly limited.
What should I do about this?
Now is the time to plan. As you set your organization’s budget for upcoming years, take a look at your unrelated business activities and how you categorize them. You do need to distinguish them properly—although again, how specific you need to get with those categories is still being discussed.
You should also keep track of your NOLs from tax years that started prior to December 31, 2017. Remember, those are now supercharged NOLs that can apply to any UBI basket.
Finally, contact your CPA firm for answers and assistance. Since the IRS is still taking comments and suggestions on the guidance for this new rule, changes could be in the future. James Moore’s nonprofit tax CPAs are tracking these developments and can help you navigate this and other changes resulting from tax reform.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.
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