Ever since the Tax Cuts and Jobs Act (TCJA) changed the rules about unrelated business taxable income (UBTI), nonprofits have had questions about just how those rules apply. Now there are proposed IRS regulations that nonprofits with more than one unrelated trade or business can rely on until final regulations are published. The proposed regs incorporate parts of the previous guidance in IRS Notice 2018-67, while making some critical changes.
THEN AND NOW
Before the TCJA, nonprofits with multiple unrelated businesses could aggregate the income and deductions from all unrelated businesses. That meant they could offset net income from one business with losses incurred from another, reducing their total UBTI. Prior year net operating losses, or NOLs, arising from any line of business could be used to offset the total current year UBTI.
Under the TCJA’s so-called silo rule, nonprofits must calculate UBTI for each business separately. Your total UBTI now is the sum of the UBTI for each business, less the $1,000 specific deduction allowed when computing UBTI and any deduction for charitable contributions made.
But the TCJA doesn’t set out criteria for determining whether an organization has more than one unrelated business or describe how to identify such separate businesses. In response to the resulting confusion, the IRS in 2018 published Notice 2018-67 to provide guidance until proposed regulations came out. According to those proposed regs, nonprofits can rely on them, the notice, or any good faith method until the final regulations are published.
Identification of separate businesses
Notice 2018-67 allows you to use the North American Industry Classification System (NAICS) six-digit codes to determine whether you have more than one unrelated business. If your businesses fall within the same code, you can aggregate them as a single business.
The proposed regulations, though, would apply the two-digit NAICS codes. The two-digit codes are broader, designating sectors of economic activity such as retail trade, real estate and rental and leasing, educational services, health care and social assistance, and accommodation and food services. Your organization would apply each code only once, as one silo, regardless of whether it has businesses in different locations in that code. With only 20 two-digit codes, compared to more than 1,000 six-digit codes, this change should make it easier to identify silos and track the NOLs for each.
Treatment of NOLs
Among other things, the proposed regs also address the “ordering rules” on the application of NOLs. An organization can have two types of NOLs — pre-2018 NOLs (which aren’t siloed to a specific unrelated business) and post-2017 NOLs (which are siloed to a specific unrelated business). The former can be used to offset 100% of taxable income from all silos. The latter generally can offset only 80% of the specific silo that generated them.
If you have both pre-2018 and post-2017 NOLs, you can fully use your pre-2018 NOLs in a given tax year by deducting them from your total UBTI. You then would deduct any post-2017 NOLs from the UBTI of the specific separate unrelated business.
Aggregation of partnership UBTI
The proposed regulations tweak Notice 2018-67’s guidance for nonprofits that have investments in partnerships with multiple unrelated businesses (for example, in hedge funds). You generally can — but aren’t required to — aggregate the UBTI from all of your “qualified partnership interests” that satisfy the de minimis or control test.
“Among other things, the proposed regs address the “ordering rules” on the application of NOLs.”
These tests have been simplified since Notice 2018-67. Under the de minimis test, you can hold no more than 2% of the profits interest or the capital interest in the partnership. The control test is satisfied if you directly hold no more than 20% of the partnership’s capital interest and have no control over the partnership.
Time to amend?
The shift to two-digit NAICS codes could make it worthwhile for your organization to amend tax returns that applied the six-digit codes. You could qualify for a refund and increase your available NOLs, which are temporarily more valuable under the Coronavirus Aid, Relief, and Economic Security Act. Your CPA can help you determine how to make the most of the new regulations.