Par. 5. Section 1.512(a)-6 is proposed to be added to read as follows:
Par. 6. Section 1.512(b)-1 is proposed to be amended by: 1. Revising paragraph (a)(1). 2. Adding a new sentence to the end of paragraph (a)(3). 3. Adding a new paragraph (e)(5). 4. Adding new paragraphs (g)(4) and (5). The revisions and additions read as follows:
(a) More than one unrelated trade or business —(1) In general. An organization with more than one unrelated trade or business must compute unrelated business taxable income (UBTI), including for purposes of determining any net operating loss (NOL) deduction, separately with respect to each such trade or business, without regard to the specific deduction in section 512(b)(12). An organization with more than one unrelated trade or business computes its total UBTI under paragraph (g) of this section.
(2) Separate trades or businesses. For purposes of section 512(a)(6)(A) and paragraph (a)(1) of this section, an organization identifies its separate unrelated trades or businesses using the methods described in paragraphs (b) through (e) of this section.
(b) North American Industry Classification System —(1) In general. Except as provided in paragraphs (c) through (e) of this section, an organization will identify each of its separate unrelated trades or businesses using the first two digits of the North American Industry Classification System code (NAICS 2-digit code) that most accurately describes the trade or business. The NAICS 2-digit code chosen must identify the unrelated trade or business in which the organization engages (directly or indirectly) and not the activities the conduct of which are substantially related to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501 (or, in the case of an organization described in section 511(a)(2)(B), to the exercise or performance of any purpose or function described in section 501(c)(3)). For example, a college or university described in section 501(c)(3) cannot use the NAICS 2-digit code for educational services to identify all its separate unrelated trades or businesses, and a qualified retirement plan described in section 401(a) cannot use the NAICS 2-digit code for finance and insurance to identify all of its unrelated trades or businesses.
(2) Codes only reported once. An organization will report each NAICS 2-digit code only once. For example, a hospital organization that operates several hospital facilities in a geographic area (or multiple geographic areas), all of which include pharmacies that sell goods to the general public, would include all the pharmacies under the NAICS 2-digit code for retail trade, regardless of whether the hospital organization keeps separate books and records for each pharmacy.
(3) Erroneous codes. Once an organization has identified a separate unrelated trade or business using a particular NAICS 2-digit code, the organization may not change the NAICS 2-digit code describing that unrelated trade or business unless the organization can show that the NAICS 2-digit code chosen was due to an unintentional error and that another NAICS 2-digit code more accurately describes the trade or business.
(c) Activities in the nature of investments —(1) In general. An organization's activities in the nature of investments (investment activities) are treated collectively as a separate unrelated trade or business for purposes of section 512(a)(6)(A) and paragraph (a) of this section. Except as provided in paragraphs (c)(6) and (c)(8) of this section, an organization's investment activities are limited to its—
(i) Qualifying partnership interests (described in paragraph (c)(2) of this section);
(ii) Qualifying S corporation interests (described in paragraph (e)(2)(i) of this section); and
(iii) Debt-financed property or properties (within the meaning of section 514).
(2) Qualifying partnership interests —(i) Directly-held partnership interests. An interest in a partnership is a qualifying partnership interest (QPI) if the exempt organization holds a direct interest in a partnership (directly-held partnership interest) that meets the requirements of either the de minimis test (described in paragraph (c)(3) of this section) or the control test (described in paragraph (c)(4) of this section).
(ii) Indirectly-held partnership interests. If an organization does not control (within the meaning of paragraph (c)(4)(iii) of this section) a partnership in which the organization holds a direct interest but that directly-held partnership interest is not a QPI because the organization holds more than 20 percent of the capital interest, any partnership in which the organization holds an indirect interest through the directly-held partnership interest (indirectly-held partnership interest) may be a QPI if the indirectly-held partnership interest meets the requirements of the de minimis test (described in paragraph (c)(3) of this section) (look-through rule). For example, if an organization directly holds 50 percent of the capital interests of a partnership that it does not control and the directly-held partnership holds 4 percent of the capital and profits interests of lower-tier partnership A, and 10 percent of the capital and profits interests of lower-tier partnership B, the organization may aggregate its interest in lower-tier partnership A with its other QPIs because the organization indirectly holds 2 percent of the capital and profits interests of lower-tier partnership A (4 percent × 50 percent). However, the organization may not aggregate its interest in lower-tier partnership B with its QPIs because the organization indirectly holds 5 percent of the capital and profits interests of lower-tier partnership B (10 percent × 50 percent), which does not meet the requirements of the de minimis test.
(iii) Designation. An organization that has a partnership interest meeting the requirements of paragraph (c)(2)(i) or (ii) of this section in a taxable year may designate that partnership interest as a QPI by including its share of partnership gross income (and directly connected deductions) with the gross income (and directly connected deductions) from its other investment activities (see paragraph (c)(1) of this section) in accordance with forms and instructions. Any partnership interest that is designated as a QPI remains a QPI unless and until it no longer meets the requirements of paragraph (c)(2)(i) or (ii) of this section. For example, if an organization designates a directly-held partnership interest that meets the requirements of the de minimis rule as a QPI in one taxable year, the organization cannot, in the next taxable year, use NAICS 2-digit codes to describe the partnership trades or businesses that are unrelated trades or businesses with respect to the organization unless the directly-held partnership interest fails to meet the requirements of both the de minimis test and the control test.
(3) De minimis test. A partnership interest is a QPI that meets the requirements of the de minimis test if the organization holds directly (within the meaning of paragraph (c)(2)(i) of this section) or indirectly (within the meaning of paragraph (c)(2)(ii) of this section) no more than 2 percent of the profits interest and no more than 2 percent of the capital interest.
(4) Control test —(i) In general. A partnership interest is a QPI that meets the requirements of the control test if the organization holds no more than 20 percent of the capital interest and does not control the partnership within the meaning of paragraph (c)(4)(iii) of this section.
(ii) Combining related interests. When determining an organization's percentage interest in a partnership for purposes of paragraph (c)(4)(i) of this section, the interests of a supporting organization (as defined in section 509(a)(3) and § 1.509(a)-4) or a controlled entity (as defined in section 512(b)(13)(D) and § 1.512(a)-1(l)) in the same partnership will be taken into account. For example, if an organization owns 10 percent of the capital interests in a partnership, and its supporting organization owns an additional 15 percent capital interest in that partnership, the organization would not meet the requirements of the control test because its aggregate percentage interest exceeds 20 percent (10 percent + 15 percent = 25 percent).
(iii) Control. All facts and circumstances, including the partnership agreement, are relevant for determining whether an organization controls a partnership. In any case, however, an organization controls a partnership if—
(A) The organization, by itself, may require the partnership to perform, or may prevent the partnership from performing, any act that significantly affects the operations of the partnership;
(B) Any of the organization's officers, directors, trustees, or employees have rights to participate in the management of the partnership at any time;
(C) Any of the organization's officers, directors, trustees, or employees have rights to conduct the partnership's business at any time; or
(D) The organization, by itself, has the power to appoint or remove any of the partnership's officers or employees or a majority of directors.
(5) Reliance on Schedule K-1 (Form 1065) —(i) In general. When determining the organization's percentage interest (described in paragraph (c)(5)(ii) of this section) in a partnership for purposes of the de minimis test (described in paragraph (c)(3) of this section) and the control test (described in paragraph (c)(4) of this section), an organization may rely on the Schedule K-1 (Form 1065) (or its successor) it receives from the partnership if the form lists the organization's percentage profits interest or its percentage capital interest, or both, at the beginning and end of the year. However, the organization may not rely on the form to the extent that any information about the organization's percentage interest is not specifically provided. For example, if the Schedule K-1 (Form 1065) an organization receives from a partnership lists the organization's profits interest as “variable” but lists its percentage capital interest at the beginning and end of the year, the organization may rely on the form only with respect to its percentage capital interest.
(ii) Determining percentage interest. For purposes of paragraph (c)(5)(i) of this section, an organization determines its percentage interest by taking 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. For example, if an organization acquires an interest in a partnership that files on a calendar year basis in May and the partnership reports on Schedule K-1 (Form 1065) 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 organization will be considered to have held 2 percent of the profits interest in that partnership for that year ((3 percent + 1 percent)/2).
(6) UBTI from the investment activities of organizations subject to section 512(a)(3). For purposes of paragraph (c)(1) of this section, UBTI from the investment activities of an organization subject to section 512(a)(3) includes any amount that—
(i) would be excluded from the calculation of UBTI under section 512(b)(1), (2), (3), or (5) if the organization were subject to section 512(a)(1);
(ii) is attributable to income set aside (and not in excess of the set aside limit described in section 512(a)(3)(E)), but not used, for a purpose described in section 512(a)(3)(B)(i) or (ii); or
(iii) is in excess of the set aside limit described in section 512(a)(3)(E).
(7) Transition rule for certain partnership interests —(i) In general. If a directly-held partnership interest acquired prior to August 21, 2018, is not a QPI, an organization may treat such partnership interest as a separate unrelated trade or business for purposes of section 512(a)(6) regardless of the number of unrelated trades or businesses directly or indirectly conducted by the partnership. For example, if an organization has a 35 percent capital interest in a partnership acquired prior to August 21, 2018, it can treat the partnership as a single trade or business even if the partnership's investments generated UBTI from lower-tier partnerships that were engaged in multiple trades or businesses. A partnership interest acquired prior to August 21, 2018, will continue to meet the requirement of this rule even if the organization's percentage interest in such partnership changes before the end of the transition period (see paragraph (c)(7)(iii) of this section).
(ii) Exclusivity. An organization may apply either the transition rule in paragraph (c)(7)(i) of this section or the look-through rule in paragraph (c)(2)(ii) of this section, but not both, to a partnership interest described in paragraph (c)(7)(i) of this section that also qualifies for application of the look-through rule described in paragraph (c)(2)(ii).
(iii) Transition period. An organization may rely on this transition rule until the first day of the organization's first taxable year beginning after [DATE OF PUBLICATION OF THE FINAL RULES IN THE FEDERAL REGISTER ].
(8) Limitations —(i) Social clubs. Paragraphs (c)(2) (regarding QPIs) and (c)(7) (transition rule for certain partnership interests) of this section do not apply to social clubs described in section 501(c)(7).
(ii) General partnership interests. Any partnership in which an organization is a general partner is not a QPI within the meaning of paragraph (c)(2) of this section, regardless of the organization's percentage interest.
(iii) Application of other sections. This paragraph (c) will not otherwise impact application of section 512(c) and the fragmentation principle under section 513(c).
(d) Income from certain controlled entities —(1) Specified payments from controlled entities. If an organization (controlling organization) controls another entity (within the meaning of section 512(b)(13)(D)) (controlled entity), all specified payments (as defined in section 512(b)(13)(C)) received by a controlling organization from that controlled entity will be treated as gross income from a separate unrelated trade or business for purposes of paragraph (a) of this section. If a controlling organization receives specified payments from two different controlled entities, the payments from each controlled entity are treated as a separate unrelated trade or business. For example, a controlling organization that receives rental payments from two controlled entities will have two separate unrelated trades or businesses, one for each controlled entity. The specified payments from a controlled entity will be treated as gross income from one trade or business regardless of whether the controlled entity engages in more than one unrelated trade or business or whether the controlling organization receives more than one type of specified payment from that controlled entity.
(2) Certain amounts derived from controlled foreign corporations. All amounts included in UBTI under section 512(b)(17) will be treated as income derived from a separate unrelated trade or business for purposes of paragraph (a) of this section.
(e) S corporation interests —(1) In general. Except as provided in paragraph (e)(2) of this section, if an organization owns stock in an S corporation (S corporation interest), such S corporation interest will be treated as an interest in a separate unrelated trade or business for purposes of paragraph (a) of this section. Thus, if an organization owns two S corporation interests, neither of which is described in paragraph (e)(2) of this section, the exempt organization will report two separate unrelated trades or businesses, one for each S corporation interest. The UBTI from an S corporation interest is the amount described in section 512(e)(1)(B).
(2) Exception —(i) Qualifying S corporation interest. Notwithstanding paragraph (e)(1) of this section, an organization may aggregate its UBTI from an S corporation interest with its UBTI from other investment activities (described in paragraph (c)(1) of this section) if the organization's ownership interest (by percentage of stock ownership) in the S corporation meets the criteria for a QPI as described in paragraph (c)(2)(i) of this section (qualifying S corporation interest).
(ii) Reliance on Schedule K-1 (Form 1120-S). When determining how much S corporation stock an organization owns for purposes of paragraph (e)(2)(i) of this section, the organization may rely on the Schedule K-1 (Form 1120-S) (or its successor) it receives from the S corporation if the form lists the organization's percentage of stock ownership for the year.
(f) Allocation of deductions. An organization must allocate deductions between separate unrelated trades or businesses using the method described in § 1.512(a)-1(c).
(g) Total UBTI —(1) In general. The total UBTI of an organization with more than one unrelated trade or business is the sum of the UBTI computed with respect to each separate unrelated trade or business (as identified under paragraph (a)(2) of this section and subject to the limitation described in paragraph (g)(2) of this section), less a specific deduction under section 512(b)(12).
(2) UBTI not less than zero. For purposes of paragraph (g)(1) of this section, the UBTI with respect to any separate unrelated trade or business identified under paragraph (a)(2) of this section cannot be less than zero.
(h) Net operating losses —(1) In general. For taxable years beginning after December 31, 2017, an exempt organization with more than one unrelated trade or business determines the NOL deduction allowed by sections 172(a) and 512(b)(6) separately with respect to each of its unrelated trades or businesses. Accordingly, if an exempt organization has more than one unrelated trade or business, § 1.512(b)-1(e) applies separately with respect to each such unrelated trade or business.
(2) Coordination of pre-2018 and post-2017 NOLs. An organization with losses arising in a taxable year beginning before January 1, 2018 (pre-2018 NOLs), and with losses arising in a taxable year beginning after December 31, 2017 (post-2017 NOLs), deducts its pre-2018 NOLs from total UBTI before deducting any post-2017 NOLs with regard to a separate unrelated trade or business against the UBTI from such trade or business. Pre-2018 NOLs are taken against the total UBTI as determined under paragraph (g) of this section in the manner that results in maximum utilization of the pre-2018 NOLs in a taxable year.
(i) Applicability dates. This section is applicable to taxable years beginning on or after [DATE OF PUBLICATION OF THE FINAL RULES IN THE FEDERAL REGISTER ].
(a) * * *
(1) * * * Dividends (including an inclusion of subpart F income under section 951(a)(1)(A) or an inclusion of global intangible low-taxed income (GILTI) under section 951A(a), both of which are treated in the same manner as a dividend for purposes of section 512(b)(1)), interest, payments with respect to securities loans (as defined in section 512(a)(5)), annuities, income from notional principal contracts (as defined in § 1.837-7 or regulations issued under section 446), other substantially similar income from ordinary and routine investments to the extent determined by the Commissioner, and all deductions directly connected with any of the foregoing items of income must be excluded in computing unrelated business taxable income.
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(3) * * * The exclusion under paragraph (a)(1) of this section of an inclusion of subpart F income under section 951(a)(1)(A) or an inclusion of GILTI under section 951A(a) from income (both inclusions being treated in the same manner as dividends) is applicable to taxable years beginning on or after [DATE OF PUBLICATION OF THE FINAL RULES IN THE FEDERAL REGISTER ]. However, an organization may choose to apply this exclusion to taxable years beginning before [DATE OF PUBLICATION OF THE FINAL RULES IN THE FEDERAL REGISTER ].
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(e) * * *
(5) See § 1.512(a)-6(h) regarding the computation of the net operating loss deduction when an organization has more than one unrelated trade or business.
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(g) * * *
(4) The term unrelated business taxable income as used in section 512(b)(10) and (11) refers to unrelated business taxable income after application of section 512(a)(6).
(5) Paragraph (g)(4) of this section is applicable to taxable years beginning on or after [DATE OF PUBLICATION OF THE FINAL RULES IN THE FEDERAL REGISTER ].
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