SECTION 6. INTERIM AND

TRANSITION RULES FOR PARTNERSHIP INVESTMENTS

.01 Aggregation of Income and Directly Connected Deductions

(1) In General . Except as provided in section 6.01(2) through (4) of this notice, exempt organizations with partnership investments should use a reasonable, goodfaith interpretation of §§ 511 and 514, considering all the facts and circumstances, when identifying separate trades or businesses for purposes of § 512(a) (6)(A) until the issuance of proposed regulations (see section 3.02 of this notice).

(2) Interim Rule for Aggregation of Qualifying Partnership Interests under the De Minimis and Control Tests . Pending publication of proposed regulations, an exempt organization may aggregate its UBTI from its interest in a single partnership with multiple trades or businesses, including trades or businesses conducted by lower-tier partnerships, as long as the directly-held interest in the partnership meets the requirements of either the de minimis test (described in section 6.02 of this notice) or the control test (described in section 6.03 of this notice) (“qualifying partnership interest”). Additionally, under this interim rule, an exempt organization may aggregate all qualifying partnership interests and treat the aggregate group of qualifying partnership interests as com

prising a single trade or business for purposes of § 512(a)(6)(A).

(3) Transition Rule . Pending publication of proposed regulations, an exempt organization may follow the transition rule (described in section 6.04 of this notice) for partnership interests with respect to which it is not applying the interim rule described in section 6.01(2) of this notice.

(4) Limitations . The interim rule and the transition rule do not apply to exempt organizations described in § 501(c)(7) that are subject to § 512(a)(3). See section 7 of this notice. Furthermore, these rules do not otherwise impact the application of § 512(c) and the fragmentation principle under § 513(c).

.02 De minimis test

(1) In general . A partnership interest is a qualifying partnership interest that meets the requirements of the de minimis test if the exempt organization holds directly no more than 2 percent of the profits interest and no more than 2 percent of the capital interest. But see section 6.02(2)(b) of this notice for rules requiring the combining of related interests in certain circumstances.

(2) Percentage Interest . (a) Reliance on Schedule K-1 . In determining the exempt organization’s percentage interest in a partnership, the exempt organization may rely on the Schedule K-1 it receives from the partnership. In Part II, line J, a partnership enters the partner’s share of profit, loss, and capital interests at the beginning and the ending of the partnership’s taxable year. An organization will be considered to have no more than 2 percent of the profits or capital interests in the case of a partnership, if the average of the organization’s percentage interest at the beginning and the end of the partnership’s taxable year, or, in the case of a partnership interest held for less than a year, the percentage interest held at the beginning and end of the period of ownership within the partnership’s taxable year, entered in Part II, line J, of Schedule K-1 is no more than 2 percent (without regard to the number of days each such percentage is held during the taxable year). For example, if an exempt organization acquires an interest in a partnership that files on a calendar year basis in May and the partnership reports in Part II, Line

Bulletin No. 2018–36 413 September 4, 2018

J, of Schedule K-1 that the partner held a 3 percent profits interest at the date of acquisition but held a 1 percent profits interest at the end of the calendar year, the exempt organization will be considered to have held 2 percent of the profits interest in that partnership for that year ((3 percent � 1 percent)/2 � 2 percent). To the extent that a specific profits interest is not identified in Part II, Line J, of Schedule K-1, an organization does not meet the de minimis test.

(b) Combining Related Interests . (i) In General . When determining an exempt organization’s percentage partnership interest, the interest of a disqualified person, a supporting organization, or a controlled entity in the same partnership will be taken into account. For example, if an exempt organization owns 1.5 percent of the profits interests in a partnership and a disqualified person with respect to the exempt organization owns an additional 1 percent profits interest in that partnership, the exempt organization would not meet the requirements of the de minimis test because its aggregate percentage interest exceeds 2 percent. However, the exempt organization may still be able to aggregate the income (and directly connected deductions) from that partnership interest with other qualifying partnership interests if the partnership interest meets the requirements of the control test (described in section 6.03 of this notice).

(ii) Disqualified Person . For purposes of section 6.02(2)(b)(i) of this notice, the term “disqualified person” has the same meaning as in § 4958(f).

(iii) Supporting Organization . For purposes of section 6.02(2)(b)(i) of this notice, the term “supporting organization” has the same meaning as in § 509(a)(3).

(iv) Controlled Entity . For purposes of section 6.02(2)(b)(i) of this notice, the term “controlled entity” has the same meaning as in § 512(b)(13)(D).

.03 Control Test

(1) In General . A partnership interest is a qualifying partnership interest that meets the requirements of the control test if the exempt organization (i) directly holds no more than 20 percent of the capital interest; and (ii) does not have control or influence over the partnership. The rules in section 6.02(2)(b) of this no

tice requiring the combination of related interests also apply for purposes of the control test.

(2) Reliance on Schedule K-1 . When determining the exempt organization’s percentage interest in a partnership the exempt organization may rely on the Schedule K-1 it receives from the partnership. An organization will be considered to have no more than 20 percent of the capital interest, if the average of the organization’s percentage interest at the beginning and the end of the partnership’s taxable year, or, in the case of a partnership interest held for less than a year, the percentage interest held at the beginning and end of the period of ownership within the partnership’s taxable year, entered in Part II, line J, of Schedule K-1 is no more than 20 percent (without regard to the number of days each such percentage is held during the taxable year).

(3) Control or Influence . All facts and circumstances are relevant for determining whether an exempt organization has control or influence over a partnership. An exempt organization has control or influence if the exempt organization may require the partnership to perform, or may prevent the partnership from performing, any act that significantly affects the operations of the partnership. An exempt organization also has control or influence over a partnership if any of the exempt organization’s officers, directors, trustees, or employees have rights to participate in the management of the partnership or conduct the partnership’s business at any time, or if the exempt organization has the power to appoint or remove any of the partnership’s officers, directors, trustees, or employees.

.04 Transition rule

A previously acquired partnership interest may be difficult to modify to meet the de minimis test (as described in section 6.02 of this notice) or control test (as described in section 6.03 of this notice) under the interim rule and the exempt organization may have to incur significant transactions costs to do so. Thus, an organization may choose to apply the following transition rule, if applicable, for a partnership interest acquired prior to August 21, 2018: an exempt organization may treat each such partnership interest as

comprising a single trade or business for purposes of § 512(a)(6) whether or not there is more than one trade or business directly or indirectly conducted by the partnership or lower-tier partnerships. For example, if an organization has a thirtyfive percent interest in a partnership prior to August 21, 2018, it can treat the partnership as being in a single unrelated trade or business even if the partnership’s investments generated UBTI from various lower-tier partnerships that were engaged in multiple types of trades or businesses.

.05 Unrelated Debt-Financed Income . The income from qualifying partnership interests permitted to be aggregated under the interim rule includes any unrelated debt-financed income (within the meaning of § 514) that arises in connection with the qualifying partnership interest that meets the requirements of either the de minimis test or the control test. See §§ 512(b)(4) and 514. For example, assume an exempt organization has an interest in a hedge fund that is treated as a partnership for federal income tax purposes, the interest is a qualifying partnership interest that meets the requirements of the de minimis test, and the hedge fund regularly trades stock on margin. Ordinarily, the dividends from such stock and any income (or loss) from the sale, exchange, or other disposition of such stock would be excluded from UBTI under § 512(b)(1) and (5). However, because all or a portion of the stock’s purchase is debtfinanced, § 512(b)(4) requires that all of or a portion (depending on the debtbasis percentage applied) of the dividend income (if any) and any income (or loss) from the sale of the stock be included in UBTI. For the purpose of the interim rule, the exempt organization may aggregate unrelated debt-financed income generated by the hedge fund with any other UBTI generated by any of the hedge fund’s trades or businesses that are unrelated trades or businesses with respect to the exempt organization.

Similarly, any unrelated debt-financed income that arises in connection with a partnership interest that meets the requirements of the transition rule may be aggregated with the other UBTI that arises in connection with that partnership interest.

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SECTION 7. SOCIAL CLUBS, VOLUNTARY EMPLOYEES’ BENEFICIARY ASSOCIATIONS, AND SUPPLEMENTAL UNEMPLOYMENT COMPENSATION BENEFITS TRUSTS

Section 512(a)(3) provides special rules applicable to exempt organizations described in § 501(c)(7) (social clubs), (9) (voluntary employees’ beneficiary associations (VEBAs)), and (17) (supplemental unemployment compensation benefits trusts (SUBs)). For these exempt organizations, § 512(a)(3)(A) provides that UBTI means the gross income (excluding any exempt function income), less the deductions allowed by Chapter 1 of the Code that are directly connected with the production of the gross income (excluding exempt function income), both computed with the modifications provided in § 512(b)(6) (the NOL deduction), (10) (charitable contribution deduction by exempt organizations), (11) (charitable contribution deduction by certain trusts), and (12) (specific deduction). Thus, social clubs, VEBAs, and SUBs are taxed under § 511 on their non-exempt function income, which generally includes investment income and income derived from an unrelated trade or business.

In particular, § 512(a)(3)(B) defines “exempt function income” as the gross income from dues, fees, charges, or similar amounts paid by members of the organization as consideration for providing such members or their dependents or guests goods, facilities, or services in furtherance of the purposes constituting the basis for the organization’s tax-exempt status. However, § 512(a)(3)(B) specifically excludes from the definition of “exempt function income” gross income derived from any unrelated trade or business regularly carried on by such organization (computed as if the organization were subject to § 512(a)(1)). ⁵ For example, a social club’s nonmember income is treated as gross income from an unrelated trade or business under § 512(a)(3). See Rev. Rul. 2003–64, 2003–1 C.B. 1036. Ac

cordingly, even though § 512(a)(3) uses terminology different from § 512(a)(1), § 512(a)(6) applies to an organization subject to § 512(a)(3) if such organization has more than one unrelated trade or business. For example, a social club that receives nonmember income from multiple sources, such as from a dining facility and from a retail store, would have more than one unrelated trade or business and therefore be subject to the requirements of § 512(a)(6).

The Treasury Department and the IRS anticipate that any rules issued regarding how an exempt organization identifies separate trades or businesses for purposes of § 512(a)(6)(A) will apply equally under § 512(a)(1) and (3). ⁶ Nonetheless, because social clubs, VEBAs, and SUBs are taxed differently than other exempt organizations under § 511, the Treasury Department and the IRS request comments regarding any additional considerations that should be given to how § 512(a)(6) applies within the context of § 512(a)(3). In particular, the Treasury Department and the IRS request comments regarding how these exempt organizations’ investment income should be treated for purposes of § 512(a)(6).