IRS Announces Guidance for “Siloing” Separate Unrelated Businesses
One of the more significant changes made by the Tax Cuts and Jobs Act of 2017 was to require tax-exempt organizations to separately calculate unrelated business income tax for each unrelated trade or business. Instead of offsetting all losses from all income attributable to all unrelated trade or business activities, organizations are now required to “silo” each trade and business and calculate unrelated business income tax for each. The statutory text of the Act was silent about how to determine if an organization has more than one unrelated trade or business or how to identify separate trades or businesses. The IRS previously issued guidance that allowed organizations to consider “all the facts and circumstances” in determining if it had multiple or separate trades or businesses. This standard was vague and not very helpful to organizations seeking concrete guidance on making these determinations.
The IRS recently published proposed regulations that provide more detailed guidance about what constitutes separate trades and businesses. The proposed regulations can be viewed in Volume 85, No. 80 of the Federal Register, available here. The proposed regulations require organizations to identify each separate unrelated trade or business using the first two digits of the North American Industry Classification System (NAICS) code that best describes the unrelated trade or business. The NAICS is a hierarchical system for classifying the U.S. economy into sectors and categories using numeric codes (the NAICS Manual is available here). The first two digits of the NAICS will classify a trade or business in one of the 20 sectors of the U.S. economy. Classifying an unrelated trade or busines by the first two NAICS digits allows organizations to broadly categorize their activities. The consequence is that organizations will likely have considerable flexibility to offset gains in one activity with losses in another. The IRS had considered using all six digits of the NAICS code to determine each unrelated trade or business. Since the NAICS consists of more than 1,000 six-digit codes, using all six digits would have required organizations to identify each trade or business at a granular level. Since some trades or businesses can be described by multiple six-digital codes, use of that system would have introduced considerable subjectivity and administrative burden to the classification process. More importantly, organizations would have been much more restricted in offsetting the gains from one activity with losses from another.
The proposed regulations further clarify that the NAICS code selected for the unrelated trade or business should not be the code that identifies the exempt organization’s exempt activities. For example, a college or university that rents parking to the general public would not identify this trade or business as “educational services” under code 61, but instead as “other services” under code 81. The proposed regulations further provide that an organization’s investment activities are classified together as a separate unrelated trade or business if they constitute qualifying partnership or S corporation interests or debt-financed property, subject to certain exceptions.
The regulations are proposed to apply to taxable years that begin on and after they are published as final regulations. For prior tax years, organizations may rely on the regulations or continue to rely on earlier guidance provided by the IRS. Please contact us if you would like our assistance determining how to calculate unrelated business income tax under the new requirements.
This article is provided for general information and should not be relied upon as legal advice for a specific situation. If you are in need of specific advice or legal representation, please do not hesitate to contact us.
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