SECTION 3. SEPARATE — Internal Revenue Bulletin 2018-36

OR BUSINESS

.01 In General

In the case of any exempt organization with more than one unrelated trade or business, § 512(a)(6)(A) requires the organization to calculate UBTI, including for purposes of determining any NOL deduction (discussed in section 9 of this notice), separately with respect to each such trade or business. In enacting § 512(a)(6), Congress did not provide criteria for determining whether an exempt organization has more than one unrelated trade or business or how to identify separate unrelated trades or businesses for purposes of calculating UBTI. The Treasury Department and the IRS intend to propose regulations for determining whether an exempt organization has more than one unrelated trade or business for purposes of § 512(a)(6) and how to identify separate trades or businesses for purposes of calculating UBTI under § 512(a)(6)(A).

.02 Reasonable, Good-Faith Interpretation of §§ 511 through 514

Pending issuance of proposed regulations, and pursuant to additional interim guidance provided in section 6 of this notice, exempt organizations may rely on a reasonable, good-faith interpretation of §§ 511 through 514, considering all the facts and circumstances, when determining whether an exempt organization has more than one unrelated trade or business for purposes of § 512(a)(6). A reasonable, good-faith interpretation includes using the North American Industry Classification System 6-digit codes described in section 3.03.

The Treasury Department and the IRS note that the fragmentation principle in § 513(c) and § 1.513–1(b), and related guidance, may also provide helpful guidance. Prior to the passage of § 512(a)(6), the fragmentation principle was primarily used to separate unrelated trades or businesses from exempt activities, but it might also have utility in identifying separate

See § 1.512(c)–1 (describing how UBTI is calculated in a situation in which an exempt organization’s distributive share of partnership income consists of both UBTI and income that is excluded from the calculation of UBTI). In determining whether a partnership conducts one or more trades or businesses that are unrelated trades or businesses with respect to an exempt organization partner, the exempt organization would use the applicable definition of “unrelated trade or business” in § 513(a) or (b). ² Section 512(c) applies regardless of whether an exempt organization is a general or limited partner. Rev. Rul. 79–222, 1979–2 C.B. 236.

Except as described in § 512(a)(3) (discussed in section 7 of this notice), exempt organizations exclude from the calculation of UBTI gross income from dividends, interest, annuities, etc.; royalties; rents; and gains and losses from the sale, exchange, or other disposition of property. See § 512(b)(1), (2), (3), & (5). The reason that these and “similar items” are excluded from UBTI is because Congress indicated that such items “are not likely to result in serious competition for taxable businesses having similar income.” S. Rep. No. 81–2375, at 30–31 (1950). Additionally, Congress stated that “investmentproducing incomes of these types have long been recognized as a proper source of revenue for [exempt] organizations and trusts.” Id. However, gross income from other sources in the nature of investments are not specifically excluded by § 512(b) and are generally included in the calculation of UBTI. Such gross income could include an exempt organization’s share (whether or not distributed) of the gross income of a partnership when the exempt organization is a partner and the partnership is engaged in one or more trades or businesses that are unrelated trades or businesses with respect to the exempt organization partner. ³

An exempt organization may engage in more than one unrelated trade or business. Prior to the enactment of § 512(a)(6), § 1.512(a)–1(a) provided that, with respect to an exempt organization that derives gross income from the regular con

duct of two or more unrelated trades or businesses, UBTI was the aggregate gross income from all such unrelated trades or businesses less the aggregate deductions allowed with respect to all such unrelated trades or businesses. However, § 512(a)(6) changes this calculation for exempt organizations with more than one unrelated trade or business. Congress intended “that a deduction from one trade or business for a taxable year may not be used to offset income from a different unrelated trade or business for the same taxable year.” H.R. Rep. No. 115–466, at 548 (2017). Specifically, § 512(a)(6) provides that, in the case of any exempt organization with more than one unrelated trade or business:

(A) UBTI, including for purposes of determining any NOL deduction, shall be computed separately with respect to each trade or business and without regard to § 512(b)(12) (allowing a specific deduction of $1,000),

(B) The UBTI of such organization shall be the sum of the UBTI so computed with respect to each trade or business, less a specific deduction under § 512(b)(12), and

Thus, § 512(a)(6) no longer allows aggregation of income and deductions from all unrelated trades or businesses. Section 512(a)(6) applies to taxable years beginning after December 31, 2017, but, as discussed in more detail in section 9 of this notice, not to NOLs arising before January 1, 2018, that are carried over to taxable years beginning on or after such date.

Separately, section 14201 of the Act added new § 951A of the Code. Section 951A(a) provides that “each person who is a United States shareholder of any controlled foreign corporation for any taxable year of such United States shareholder shall include in gross income such shareholder’s global intangible low-taxed income for such taxable year.”

2Because IRAs described in § 408 are subject to the tax imposed by § 511, under § 408(e), and IRAs are most similar to § 401(a) trusts, it is reasonable to apply the definition of “unrelated trade or business” described in § 513(b) to IRAs. The Treasury Department and the IRS intend to provide that the § 513(b) definition of unrelated trades or businesses should be used in application of § 511 for accounts subject to the tax in § 511 pursuant to § 408(e).

3In the case of a trust that is exempt from tax under § 501(a) that is described in § 401(a) or § 501(c)(17), § 513(b) defines “unrelated trade or business” as any trade or business regularly carried on a partnership of which it is a member.

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trades or businesses for purposes of § 512(a)(6)(A). The fragmentation principle provides that an activity does not lose its identity as a trade or business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may, or may not, be related to the exempt purposes of an organization. For example, the regular sale of pharmaceutical supplies to the general public by a hospital pharmacy does not lose its status as a trade or business merely because the pharmacy also furnishes supplies to the hospital and patients of the hospital in accordance with its exempt purposes or in compliance with the terms of § 513(a)(2) (stating, in part, that the term “trade or business” does not include any trade or business that is carried on by an organization described in § 501(c)(3) or a state college or university primarily for the convenience of its members, students, patients, officers, or employees). See § 1.513–1(b). Similarly, activities of soliciting, selling, and publishing commercial advertising do not lose their statuses as trades or businesses even though the advertising is published in an exempt organization periodical that contains editorial matter related to the exempt purposes of the organization. Id. Additionally, several revenue rulings provide examples of how the fragmentation principle has been applied. See, e.g., Rev. Rul. 78–145, 1978–1 C.B. 169 (regarding the sale of blood products by a blood bank).

.03 Possible Methods for Identifying Separate Trades or Businesses

There is no general statutory or regulatory definition defining what constitutes a “trade or business” for purposes of the Internal Revenue Code. Whether an activity constitutes a trade or business may vary depending on which Code section is involved. See generally Commissioner v. Groetzinger, 480 U.S. 23, 27 (1987). The Treasury Department and the IRS request comments regarding rules to identify separate trades or businesses that achieve the intent of Congress in enacting § 512(a)(6) and are administrable for exempt organizations and the IRS.

Several Code sections describe factors for determining whether an organization is engaged in a trade or business or a line

of business, including §§ 132, 162, 183, 414, and 469 (see also section 5.02 of this notice), and the regulations thereunder. The Treasury Department and the IRS have considered these Code sections and are concerned that they do not provide useful models for identifying separate trades or businesses for purposes of § 512(a)(6). Nonetheless, the Treasury Department and the IRS request comments describing whether and how these and other Code sections (and the regulations thereunder) may aid in determining how to identify an exempt organization’s separate trades or businesses for purposes of § 512(a)(6)(A).

Although some commenters have suggested the creation of a facts and circumstances test to identify separate trades or businesses for purposes of § 512(a)(6), the Treasury Department and the IRS would like to set forth a more administrable method than a facts and circumstances test alone for identifying separate trades or businesses for purposes of § 512(a)(6). A facts and circumstances test would increase the administrative burden on exempt organizations in complying with § 512(a)(6) because such organizations would have to perform a fact-intensive analysis with respect to each of their trades or businesses, document the analysis, and then track and keep records consistent with such analysis. Additionally, such a test would likely result in inconsistency across the exempt organization sector in light of differing approaches in budgeting and staffing and thus create unequal burdens and cause exempt organizations to make business decisions such as budgeting and staffing solely to avoid the requirements of § 512(a)(6). Finally, such a test would also increase the administrative burden on the IRS in implementing and enforcing § 512(a)(6) because verifying whether an exempt organization calculated its UBTI correctly would require a fact-intensive analysis of the organization’s trades or businesses and the determinations made with respect to identifying separate trades or businesses for purposes of calculating UBTI under § 512(a)(6)(A).

To provide additional guidance in proposed regulations for determining whether an exempt organization has more than one unrelated trade or business for purposes of

§ 512(a)(6) and how to identify separate trades or businesses for purposes of calculating UBTI under § 512(a)(6)(A), the Treasury Department and the IRS are considering the use of North American Industry Classification System (NAICS) codes. Prior to proposed regulations, the Treasury Department and the IRS will consider the use of NAICS 6-digit codes to be a reasonable, good-faith interpretation under section 3.02 of this notice.

The NAICS is an industry classification system for purposes of collecting, analyzing, and publishing statistical data related to the United States business economy. See EXECUTIVE OFFICE of the PRESI DENT, OFFICE of MANAGEMENTand BUDGET, NORTH AMERICAN INDUSTRY CLASSIFICATION SYSTEM (2017), available at https://www. census.gov/eos/www/naics/2017NAICS/ 2017_NAICS_Manual.pdf. For example, under a NAICS 6-digit code, all of an exempt organization’s advertising activities and related services (NAICS code 541800) might be considered one unrelated trade or business activity, regardless of the source of the advertising income. Use of all 6 digits of the NAICS codes would result in more specific categories of trades or businesses whereas use of fewer than 6 digits of the NAICS codes would result in broader categories of trades or businesses. Exempt organizations filing Form 990–T, “Exempt Organization Business Income Tax Return,” already are required to use the 6-digit NAICS codes when describing the organization’s unrelated trades or businesses in Block E. The Treasury Department and the IRS request comments regarding whether using less than 6 digits of the NAICS codes, or combining NAICS codes with other criteria, would appropriately identify separate trades or businesses for purposes of achieving the objective of § 512(a)(6). The Treasury Department and the IRS also request comments on the utility of this method, other methods, or a combination of methods that could be used for making this determination.

.04 Allocation of Directly Connected Deductions

Section 512(a)(1) permits an exempt organization with an unrelated trade or business to reduce the income from that trade or business by the deductions al

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ganization as a separate trade or business for purposes of § 512(a)(6)(A), because the debt/basis percentage used to calculate the portion of income that is unrelated debtfinanced income included in the calculation of UBTI under § 512(b)(4) is specific to each property. Similarly, an exempt organization might be required to report income from each controlled entity as income from a separate trade or business for purposes of § 512(a)(6)(A). The exempt organization would have to track and report each debtfinanced property owned directly by an exempt organization or income from each controlled entity separately, which imposes a burden both on the exempt organization and on the IRS. Accordingly, aggregating income included in UBTI under § 512(b)(4), (13), or (17) may be appropriate in certain circumstances. The Treasury Department and the IRS therefore request comments regarding the treatment under § 512(a)(6) of income that is not from a partnership but is included in UBTI under § 512(b)(4), (13), and (17).