A.2. Trade or Business Carried on Within a Larger Aggregate of Other Activities…

(1) The term “trade or business” isn’t limited to integrated aggregates of assets,

activities, and goodwill which comprise businesses for the purposes of certain other provisions of the Code. Generally, activities of producing or distributing goods or performing services from which a particular amount of gross income is derived won’t lose identity as trade or business merely because they are 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 the organization. See Section 513(c) and Treas. Reg. 1.513-1(b). This is commonly known as the “fragmentation rule.”

(2) Where an activity carried on for the production of income constitutes an

unrelated trade or business, no part of such trade or business shall be excluded from such classification merely because it doesn’t result in profit. See Section 513(c) and Treas. Reg. 1.513-1(b). Activities classified as unrelated business are also subject to siloing into separate unrelated trades or businesses for purposes of Section 512(a)(6) (discussed in Part III.G of this document).

(3) The fragmentation rule initially appeared as a regulation in 1967, directed

partly to periodical advertising. In 1969, Congress affirmed this treatment of advertising and similar activities carried on for the production of income as unrelated trade or business subject to tax even though advertising, for example, may appear in a periodical related to the exempt purposes of an organization. Section 513(c); H.R. Rep. No. 91–413 (Part 1), 91st Cong., 1st Sess. 45 (1969), 1969–3 C.B. 229.

(4) In United States v. American College of Physicians, 475 U.S. 834 (1986), the

court held that when an exempt organization publishes a periodical containing articles and editorials pertaining to its exempt purpose, the sale of advertising in the publications is an unrelated trade or business if the conduct of the advertising business doesn’t contribute importantly to the organization’s exempt purposes (which it didn’t under the facts of the case). The particular purpose behind the enactment of Section 513(c) and Treas. Reg. 1.513-1(b) is to "fragment" out unrelated business activity (in this case the advertising portion of the periodical, not substantially related) from related business or other exempt-function activity (the educational or editorial portion of the periodical), for purposes of unrelated trade or business.

(5) The fragmentation rule may apply to separate out or “fragment,” as a separate

trade or business, sales to non-members from sales to members that are excepted from unrelated business under the convenience exception of Section

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513(a)(2), where the sales to non-members aren’t merely casual but regularly carried on.

a. For example, in Rev. Rul. 68-374 (discussed in Part II.B.3 of this

document) the regular sale of pharmaceutical supplies to the general public by a hospital pharmacy didn’t lose identity as an unrelated trade or business merely because the pharmacy also furnishes supplies to the hospital and patients of the hospital in accordance with its exempt purposes.

b. See also Rev. Rul. 78-98, 1978-1 C.B. 167 (public use of school’s ski

facility was unrelated business but use by students wasn’t).

(6) Similarly, sales of a particular line of merchandise may be considered

separately to determine their relatedness to the exempt purpose, and thus “fragmented” between related and unrelated business.

a. For example, in Rev. Rul. 73-105, 1973-1 C.B. 264, the sale of scientific

books and city souvenirs by a museum of folk-art exempt from tax under Section 501(c)(3) constituted unrelated trade or business even though other items sold in the museum shop are related to its exempt function.