Good Counsel: New Silo Rules for UBIT
Tax reform brought changes that could raise your unrelated business income tax bill.
For associations, there’s good news and bad news in last year’s Tax Cuts and Jobs Act. The good news is that if your association is a corporation, the tax rate on unrelated trade or business income, like the tax rate on income for any other corporation, has been lowered to a flat 21 percent.
But there is bad news for the unrelated business income tax (UBIT). Many associations generate UBI from nondues revenue such as sales, consulting services, investments in partnerships, advertising income, and other activities. If an activity is unrelated to the association’s exempt purpose and is a regularly-carried-on trade or business, then it will most likely generate UBI. This is true whether the activity is conducted by the association itself or indirectly through a partnership.
Under the new rules, associations can only offset unrelated business income from an activity against the expenses from that same activity—in other words, each activity is in its own silo or basket. This means that an association will not be able to write off expenses from an activity that produces losses; it will have to wait until the activity turns a profit. Meanwhile, profitable activities will be taxed on that profit now.
These changes may lead to more taxes, because previously all unrelated losses could be used to offset all unrelated business income. Losses incurred before January 1, 2018, can be taken against total UBIT after the silo rule has been applied.
Another consequence of this change is that now associations will have to determine what constitutes a separate trade or business and allocate expenses to that business.
The IRS has issued guidance (IRS Notice 2018–67) that allows associations to rely on a reasonable good-faith interpretation of the tax code, using the North American Industry Classification System codes for classifying separate trade or business activities.
Where an association has UBI through partnership holdings, all the partnerships’ gains and losses can be aggregated if the organization owns only a small amount of a partnership or does not control it. Interests of certain “related parties” must be included to meet these tests. Also, partnerships can be treated as one trade or business if the organization acquired them before August 21, 2018.
These new rules add another layer of complexity to calculating UBIT. Association executives should consult with advisors to help them navigate the new rules.