Section 512(a)(6) was added to the Internal Revenue Code as part of the Tax Cuts and Jobs Act passed in December 2017. It required that exempt organizations carrying on multiple trade or business activity must calculate UBTI separately for each trade or business. The intent of the new law was to prevent tax-exempt organizations from offsetting UBTI generated by a profitable unrelated trade or business with a loss from an unprofitable one. However, it did not make clear what activities can be grouped together as a single unrelated trade or business. Notice 2018-67, issued August 21, 2018, provides long-awaited interim guidance and transition rules, but it should be noted that it is pending the issuance of proposed regulations.
The Notice indicates that exempt organizations may “rely on a reasonable, good-faith interpretation” to determine whether the organization has more than one unrelated trade or business for purposes of applying §512(a)(6). It goes on to say that a reasonable, good-faith interpretation includes classifying separate trades or businesses according to the six-digit classification codes of the North American Industry Classification System (NAICS). However, the NAICS code system has limitations. Many unrelated trades or businesses undertaken by exempt organization do not have their own NAICS codes, and some organizations use a catchall code because there are no NAICS codes that accurately labels their activities.
The Notice specifies that the IRS is not in favor of using a facts and circumstances test for concluding the existence of separate trades or businesses. This is because it would cause more administrative burdens in performing a fact-intensive analysis – which may lead to inconsistencies in reporting across the sector because of different approaches in determining each set of facts and circumstances.
For exempt organizations investing in partnerships, the notice provides two interim safe harbors to allow the organizations to aggregate its UBTI from its interest in a single partnership with multiple trades or businesses (including activities conducted by lower-tier partnerships) and aggregate all partnership interests if one of two tests are met:
- A de minimis test which is met if the exempt organization holds directly no more than 2% of the profits interest AND no more than 2% of the capital interest of the partnership; OR
- A control test which is met if the exempt organization holds no more than 20% of the capital interest AND does not have control or influence over the partnership.
Additionally, there is a transition rule that allows, regardless of whether the de minimis test or the control test is met, tax-exempt organizations to treat a partnership interest acquired before August 21, 2018 as constituting a single trade or business.
While the Notice discussed the calculation and utilization of net operating losses (NOLs) arising before and after tax years beginning after December 31, 2017, it does not give any guidance that taxpayers may rely on at this point, particularly regarding ordering rules for pre-2018 and post-2017 NOLs. Instead, the IRS is asking for comments regarding ordering rules.
And while the Notice did provide temporary guidance on partnership trade or business groupings, it did not provide guidance on passive loss carryforwards and whether the NOL rules apply to them.
The Notice serves as a start for developing rules particularly for the interim, but the IRS is requesting comments on specific aspects of the guidance provided in the Notice – for which the deadline is December 3, 2018. Because of that deadline being close to the year-end, we do not expect the proposed regulations to be issued until sometime in 2019.