The IRS recently published final regulations related to new requirements for exempt organizations to separately compute unrelated business taxable income (UBTI) for each separate business activity they conduct. Generally, nonprofit organizations are not subject to federal income tax, except to the extent of their unrelated business taxable income. UBTI refers to income generated by a business of an exempt organization that is regularly carried on and that is not substantially related to the organization’s exempt purpose.
Consistent with §512(a)(6) and the proposed regulations, 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 specific deductions in §512(b)(12), including any net operating loss (NOL) deduction.
One of the more notable items included in the final regulations regards the requirement that exempt organizations utilize the 2-digit North American Industry Classification System Code (NAICS) when identifying separate trades or businesses to properly apply §512(a)(6). The Treasury Department included the use of the 2-digit NACIS code (as compared to the 6-digit NACIS code) in order to simplify the application of these regulations for exempt organizations. The 2-digit NAICS codes separates trades and businesses into 20 different categories as opposed to the roughly 1,000 categories included in the 6-digit NACIS code system.
The final regulations note that for taxable years beginning after December 31, 2017, an exempt organization with more than one unrelated trade or business must determine its allowable NOL deduction separately with respect to each of its unrelated trade or businesses. The proposed regulations provided that an organization with losses arising in a taxable year beginning before January 1, 2018 (a “pre-2018 NOL”), and losses arising in a taxable year beginning after December 31, 2017 (a “post-2017 NOL”), deduct its pre-2018 NOL from total UBTI before deducting post-2017 NOLs with regard to separate unrelated trade or businesses.”
The IRS further clarified that an exempt organization may allocate all of its pre-2018 NOLs to one of its separate unrelated trade or businesses or it may allocate its pre-2018 NOL ratably among its separate unrelated trade or businesses, whichever results in greater utilization of post-2017 NOLs in that taxable year. The IRS anticipates issuing guidance on how the CARES Act’s modification to the NOL deduction affects the calculation of UBIT and NOL calculations for exempt organizations.
The final regulations also give more guidance on qualifying partnership interests, qualifying S corporation interests, and certain debt-financed properties that may also be treated as separate unrelated trade or business for Sec 512(a)(6).