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Final Regulations for Nonprofits with Multiple Revenue Streams
Unrelated business income (UBI) is defined in Regulation Section 1.513-1(a) as gross income derived by an organization from any unrelated trade or business the organization regularly carries on, less the deductions.
When looking at income, there are three criteria that must be met for UBI:
- Income must be from a trade or business.
- Such trade or business must be regularly carried on.
- Conduct of such trade or business must not be substantially related to the organization’s performance of its exempt purpose, other than through the production of funds.
When looking at income-producing activities, each activity—and all the facts and circumstances surrounding the activity—must be examined to determine the activity’s relation to the organization’s exempt purpose.
On November 19, 2020, the IRS issued final regulations under §512(a)(6) of the Internal Revenue Code (IRC). Section 512(a)(6) was added to the IRC as part of the 2017 Tax Cuts and Jobs Act and requires an exempt organization subject to the UBI tax under §511, i.e., unrelated business income tax (UBIT), that has more than one unrelated trade or business to calculate unrelated business taxable income (UBTI) separately for each trade or business, otherwise known as a “siloing.”
The final regulations provide that an exempt organization with more than one unrelated trade or business must compute UBTI separately with respect to each unrelated trade or business, without regard to the specific deduction allowed per §512(b)(12), including for purposes of determining any net operating loss (NOL) deduction. The regulations generally require that an exempt organization must identify each of its separate unrelated trades or businesses using the first two digits of the North American Industry Classification System code (NAICS two-digit code) that most accurately describes the unrelated trade or business.
An exempt organization with more than one unrelated trade or business must allocate deductions between separate unrelated trades or businesses using the reasonable-basis standard described in Regs. §1.512(a)-1(c).
An exempt organization’s investment activities in partnerships, MLPs, and alternative investments that are subject to UBIT will be treated as a separate trade or business for purposes of §512(a)(6) under the final regulations. However, qualifying partnership interests, qualifying S corporation interests, and certain debt-financed properties may be treated as separate unrelated trades or businesses for purposes of §512(a)(6).
The proposed regulations issued in April of this year reserved two issues for further consideration. The first relates to the allocation of expenses, depreciation, and similar items that are 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 §172 NOL deduction by the Coronavirus Aid, Relief, and Economic Security Act. The final regulations didn’t address these issues, but it’s anticipated the IRS will issue proposed regulations future.
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