On November 19, 2020, the Treasury Department and the Internal Revenue Service submitted to the Office of the Federal Register a draft version of final regulations (TD 9933). The regulations provide guidance on identifying when exempt organizations have more than one unrelated trade or business and how to compute unrelated business taxable income (UBTI) under the new section 512(a)(6). These final regulations make minimal changes to the proposed regulations published in April 2020.
Background
The proposed regulations started with the enactment of the Tax Cuts and Jobs Act (TCJA) in 2017. Prior to the TCJA, exempt organizations calculated UBTI by aggregating net income from all unrelated business activities conducted by the organization. This allowed losses from one unrelated trade or business to offset income from another unrelated trade or business. The TCJA ended this practice and now requires exempt organizations with more than one unrelated trade or business to calculate UBTI amounts separately for each trade or business. Exempt organizations are now required to use the two digit North American Industry Classification Systems (NAICS) Codes, effectively limiting losses to the unrelated trade or business that generated them.
How the Final Regulations Impact Investment Partnerships
There is an exception to the use of the NAICS codes when it comes to the exempt organization’s investment activities. The final regulations maintain that an exempt organization’s investment activities which include qualifying partnership interests (QPIs), qualifying S corporation interests and Debt Financed Property can be treated collectively as a separate trade or business. This aggregation rule was adopted for administrative convenience for both the exempt organization and the IRS due to the difficulty in obtaining information about the trade and business activities from partnerships, especially lower-tier partnerships. Overall, this simplifies the reporting requirements for investment partnership footnote disclosures.
Qualified Investment Partnership Criteria
A qualifying investment partnership (QIP) is a partnership interest that meets either the de minimis test or the significant participation test. The de minimis test is met if the exempt organization holds directly no more than 2 percent of the profits interest and no more than 2 percent of the capital interest. The significant participation test (called the control test in the proposed regulations) is met if the exempt organization directly holds no more than 20 percent of the capital interest and does not significantly participate in the partnership. The term “significantly participate” generally is not a defined term, but relies on facts and circumstances. The final regulations also expanded on the “look through” rule to allow an indirect interest in a lower-tier partnership that meets the de minimis test to qualify as a QIP even if the exempt organization significantly participates in the directly held upper-tier partnership.
The proposed regulations mentioned that an exempt organization that is the general partner in a partnership does not have a QPI in that partnership, regardless of percentage of interest. This general partner prohibition clause was maintained in the final regulations.
Effective Date
The final regulations have been submitted to the federal register and will become effective for tax year beginning on or after the date they are published in the federal register.
Authors: Abibat Fadoju, CPA, [email protected] | Anthony Aniello, Partner, [email protected] | Amanda McKenna, Principal, [email protected]
Withum’s Financial Services Team for any further questions.
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