The IRS has released the final rules implementing the requirement to calculate and report unrelated business income (UBI) by category of activity—the UBIT basketing rules under Section 512(a)(6) of the Internal Revenue Code that were enacted as part of the 2017 Tax Cuts and Jobs Act. Official publication in the Federal Register is expected several weeks from now, but no substantive changes are anticipated from the version released November 19 by the IRS.
The final regulations, with a few exceptions, largely reflect the Notice of Proposed Rulemaking (NPRM) published on April 24. NACUBO, along with 10 other higher education associations, submitted a June 22 letter addressing several provisions in the proposal, with recommendations that colleges and universities wished to see in the final regulations. Those adopted are noted below.
To summarize key areas of the final regulations—
Categorizing Unrelated Business Activities. The final rules retain the proposed regulation provision that directs organizations to use the first two digits of the North American Industry Classification System (NAICS) code to identify separate unrelated trades or businesses. Similar to the proposed rules, the final regulations prohibit the use of single NAICS code more than once. Institutions that operate a certain business activity at multiple geographical locations are required to roll up the information from all locations into an aggregate reporting of that activity, regardless of whether separate books and records are kept for each location.
Allocation of Expenses. The final regulations acknowledge that the gross-to-gross method may be reasonable when there is no price difference for goods and services provided to members (related) versus non-members (unrelated activity). The proposed rules had prohibited the use of an unadjusted gross-to-gross method, and NACUBO successfully urged the IRS to accept the gross-to-gross method.
Reporting of Investments. NACUBO was partially successful in urging the IRS to expand the “look-through” rule to allow an indirect interest in a lower-tier partnership that meets a de minimis test to be treated as QPI even if the institution significantly participates in the directly-hold upper-tier partnership.
According to the proposed regulations, a qualified partnership interest (QPI) may be grouped with other QPIs, debt-financed properties, and underlying S corporation interests into a single investments “basket” for reporting purposes. A partnership interest is a QPI if the exempt organization directly holds no more than 20 percent of the capital interest and does not have control over the partnership.
NACUBO pushed back against the 20-percent threshold, recommending that if an institution has 50 percent or less ownership interest in a partnership, it will meet the control test when the institution is only participating as a passive investor. Unfortunately, the final rules retain the 20-percent threshold.
In addition, the final rules rename the control test from the proposed regulations to the “significant participation” test. An institution significantly participates in a partnership if—
- It may, by itself, require the partnership to perform, or may prevent it from performing, any act that significantly affects the operations of the partnership;
- Any of the institution’s officers, directors, trustees, or employees have rights to participate in the management of the partnership or have rights to conduct the partnership’s business at any time; or
- The institution, by itself, has the power to appoint or remove any of the partnership’s officers or employees or a majority of directors.
NACUBO had urged the IRS to expand the “look-through” rule under the proposed regulations to allow an indirect interest in a lower-tier partnership that meets a de minimis test to be treated as QPI even if the institution significantly participates in the directly-held upper-tier partnership. The final rules adopted this expansion.
The final rules are effective for taxable years beginning on or after the date of publication in the Federal Register. Exempt organizations may choose to apply the final rules to earlier taxable years beginning on or after January 1, 2019, or may rely on a reasonable, good-faith interpretation of Section 512(a)(6) for such taxable years.
Explore these new rules and other UBI compliance concepts at the 2021 Unrelated Business Income Tax program, February 24-25.