The Internal Revenue Service (IRS) issued proposed Regulations (REG-106864-18) on the “siloing” of unrelated business income under §512(a)(6). The Tax Cuts and Jobs Act (“TCJA”) added this section that required tax-exempt organizations to separate their various activities into separate trades or businesses. Losses from one activity would not be allowed to be used to offset income from another—in effect placing each activity in a silo. The TCJA did not define a trade or business. In August 2018, the IRS had released interim guidance on the subject with Notice 2018-67. The proposed regulations supersede that notice.
The proposed regulations continued the use of the NAICS codes as the primary method for determining separate trades or business activities. NAICS is an industry classification system that uses up to six digits to classify trades or business. The notice used all six digits to classify activities; this resulted in over one thousand different classifications. The proposed regulations use only the two-digit method to classify activities. The result is only 20 different classifications. This should make it easier for organizations to combine similar activities into one activity.
One of the more vexing issues for exempt organizations under the new rules was the question of how to treat investment income from partnerships. If each partnership and activity were required to be accounted for separately, it would be an extremely burdensome calculation. The proposed regulations generally follow the notice in allowing organizations to group most of these activities together under one trade or business. The proposed regulations adopt both the de minimis test and control test. Under the de minimis test, if the organization owns less than 2% of the profits and capital interest of the partnership, it could grouped with other partnerships. Under the control test, if an organization owns less than 20% of the capital interest of the partnership and does not control the partnership, it can be included with the other partnership interests. The proposed regulations loosen the aggregation rules for both the de minimis test and the control test. In addition, the control test no longer requires an organization to include the interests of disqualified persons in the control test.
Overall, the proposed regulations seem to have made the application of the separate trade or business rule easier to manage and easier to group activities into broader categories.
If your organization needs assistance interpreting or applying these new rules, please let one of our exempt organization experts know.
