SECTION 2. BACKGROUND

Under § 501(a), organizations described in §§ 401(a) and 501(c) generally are exempt from federal income taxation. However, § 511(a)(1) imposes a tax (computed as provided in § 11) on the UBTI of organizations described in § 511(a)(2), which includes organizations described in §§ 401(a) and 501(c) (other than a trust described in § 511(b) or an instrumentality of the United States described in § 501(c)(1)) as well as state colleges and universities. Additionally, § 511(b)(1) imposes a tax (computed as provided in § 1(e)) on the UBTI of certain trusts described in § 511(b)(2). ¹ Organizations described in § 511(a)(2) and trusts described in § 511(b)(2) are collectively called “exempt organizations” throughout this notice, unless otherwise stated.

Section 512(a)(1) defines UBTI as the gross income derived by any exempt organization from an unrelated trade or business regularly carried on by it, less the deductions allowed by Chapter 1 that are directly connected with the carrying on of such trade or business, both computed with the modifications described in § 512(b). An exempt organization determines whether it has income from an unrelated trade or business under the general principles of §§ 511 through 514 and the Treasury regulations thereunder.

Section 513(a) defines “unrelated trade or business” as any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such exempt organization, other than trusts described in § 513(b)(2), of its charitable, educational, or other purpose or function constituting the basis for its exemption under § 501 (or, in the case of a state college or university, to the exercise or performance of any purpose or function described in § 501(c)(3)). In the case of a trust that is exempt from tax under § 501(a) and described in § 401(a) (qualified retirement plans) or § 501(c)(17) (supplemental unemployment compensation benefits trusts (SUBs)), however, § 513(b) defines “unrelated trade or business,” as any trade or business regularly carried on by such trust or by a partnership of which it is a member.

An exempt organization may conduct an unrelated trade or business directly or indirectly through another entity, such as a partnership (including any entity treated as a partnership for federal tax purposes). Section 512(c) provides that, if a trade or business regularly carried on by a partnership of which an exempt organization is a partner is an unrelated trade or business with respect to such organization, the exempt organization includes in UBTI – subject to the exceptions, additions, and limitations of § 512(b) - its distributive share of partnership gross income (whether or not distributed) and partnership deductions directly connected with such gross income.

1Section 408(e) states that an individual retirement account (IRA) is subject to the taxes imposed by § 511. Accordingly, any reference to an exempt organization in this notice includes an IRA, without regard to whether it is a traditional IRA, Roth IRA, simplified employee pension (SEP-IRA), or savings incentive match plan for employees (SIMPLE IRA).

Bulletin No. 2018–36 409 September 4, 2018