Unrelated Trade or Business Income

By Katie New, CPA

As a result of the current pandemic, tax-exempt organizations may be looking at other cash flow opportunities. Here are some helpful rules to remember regarding unrelated business income (UBI).

Any tax-exempt organization with a taxable year starting after January 1, 2018, will be subject to the new laws under the Tax Cuts and Jobs Act of 2017. One of the major changes is the new “silo” rules for unrelated business income (UBI). Any tax-exempt organization with more than one UBI stream may need to adjust their tax calculation methods used in previous years.

Before January 1, 2018, each unrelated business activity’s income or loss was calculated and subsequently netted together, regardless if they were similar activities. For example, XYZ Foundation had unrelated business activity “A” with unrelated business taxable income (UBTI) of $5,000 and another unrelated business activity “B” with the UBTI calculated as a net loss of $2,000. On the Form 990-T UBTI was a positive $3,000 and tax was computed on this number.

The new rules no longer allow aggregation of income and deductions from all sources. Going forward, each activity’s UBTI will be calculated separately, hence the term “silo”. Using the same details in the example above and assuming the activities fall into two different unrelated trade or businesses, the UBTI will be $5,000 for activity A and $0 for activity B for the year. Activity B would have their own net operating loss (NOL) that can be used for their specific activity in the future (cannot be used for activity A). Tax would be calculated using the full $5,000.

The first step in preparing for this change will be identifying revenue streams and categorizing them into trades or businesses. Recently, the IRS has provided initial guidance for possible siloing into separate trades or businesses. They indicate using a “reasonable, good faith” interpretation and offered the North American Industry Classification System (NAICS). The proposed regulations provide that the exempt organization should use the NAICS code systems and the first two digits to identify separate trade or business activities. The two-digit NAICS code chosen should align with the UBI activity, not the organizations general activity as a whole. Any trade or business that uses the same two-digit NAICS code can be netted together and reported on one form 990-T.

These rules can be complex, please consult your tax advisor.

Katie New, CPA | Senior Manager