The IRS recently issued final regulations related to the requirement to calculate and report unrelated business income (UBI) by category of activity, as required under Section 512(a)(6) of the Internal Revenue Code. These regulations provide guidance on how an exempt organization determines if it has more than one unrelated trade or business.
Tax-exempt organizations subject to tax on UBIT must calculate it separately for each business (also referred to as siloing revenue and expenses for each separate business). Organizations are prohibited from using losses from one unrelated trade or business to offset income from another under Section 512(a)(6).
Categorizing Unrelated Business Activities
The regulations direct organizations to use the first two digits of the North American Industry Classification System (NAICS) code to identify separate unrelated trades or businesses, using the code that most accurately describes the exempt organization’s trade or business activity. Organizations are prohibited from using a single NAICS code more than once.
Basketing of Certain Investments
Under the regulations, a qualified partnership interest (QPI) may be grouped with other QPIs, debt-financed properties and underlying S corporation interests into a single investment “basket” for reporting purposes. A partnership interest is a QPI if the exempt organization directly holds no more than 20% of the capital interest and does not have control over the partnership.
The preamble to the final regulations indicates the IRS plans to release additional guidance regarding unrelated business income, noting:
The proposed regulations reserved two issues for additional consideration. The first issue relates to the allocation of expenses, depreciation, and similar items shared between an exempt activity and an unrelated trade or business or between more than one unrelated trade or business. The second issue relates to changes made to the section 172 NOL deduction by the Coronavirus Aid, Relief, and Economic Security Act, Public Law 116-136, 134 Stat. 281 (2020) (CARES Act). The Treasury Department and the IRS anticipate publishing a separate notice of proposed rulemaking that will address these issues.
The final rules are effective for taxable years beginning on or after the date of publication in the Federal Register. Exempt organizations may choose to apply the final rules to earlier taxable years beginning on or after Jan. 1, 2019. They may rely on a reasonable, good-faith interpretation of Section 512(a)(6) for such taxable years.
Your higher education CPA can guide you through these final rules to help ensure you’re properly categorizing unrelated business income.
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