Previously, to determine unrelated business taxable income (“UBTI”), an organization that operates multiple unrelated trades or businesses would aggregate income from all those activities and subtracts the aggregate of deductions from that income to determine net unrelated business income/loss. As a result, an organization could use a deduction from one unrelated trade or business to offset income from another trade or business, thereby reducing total UBTI.

Under new rules, unrelated business income from an activity can only be offset against expenses from that same activity. Essentially, each UBIT activity is in its own “silo,” and organizations will not be able to deduct expenses from an activity that produces losses, while still being taxed on activities that produce gains.

The result is that a deduction/loss from one unrelated trade or business may not be used to offset the income from a different unrelated trade or business. Net losses from one resulting activity may be used to offset income from the same unrelated trade or business in another taxable year.

Final Regulations

The most impactful provisions of the final regulations perform the following functions:

  • They provide guidance on how an exempt organization subject to the unrelated business income tax determines if it has more than one unrelated trade or business, and, if so, how the exempt organization calculates unrelated business taxable income
    • The proposed rules specify that the income and expenses from any trade or business grouped under the same 2 digit NAICS classification regime can be aggregated.
  • The regulations provide that the definition of “unrelated trade or business” applies to individual retirement accounts (“IRAs”)
  • The regulations, also, provide that inclusions of subpart F income and global intangible low-taxed income (“GILTI”) are treated in the same manner as dividends for purposes of determining unrelated business taxable income

UBIT Planning

The requirement that unrelated business activity silos be created to calculate the gain and loss on each individual activity has substantial consequences and has the effect of placing exempt organizations at a competitive disadvantage to for-profit corporations, which are permitted to offset profits and losses from across the business.

Tax-exempt organizations with a variety of unrelated business activity should consider whether now is the time to incorporate a taxable subsidiary in which to conduct such operations, which would permit this aggregation and place them back on par with the private sector. This may be particularly attractive for pension trusts and charities formed as trusts which pay a top tax rate of 37% on UBTI,

Additionally, nonprofits may wish to consider assessing their UBTI producing activities in order to capture and report all expenses reasonably allocable and directly connected to that activity. This may include allocable amounts of employee compensation, investment advisory fees, and other administrative overhead.

For more information or to discuss if your tax-exempt organization is impacted by these IRS changes please
contact your Withum advisor or a member of our Tax Services Team

Business Tax Services

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