UBI Now Calculated for Each Unrelated Trade and Business Activity

Date: May 16, 2018

The Tax Cuts and Jobs Act that became effective on January 1, 2018, brought sweeping changes to the way organizations calculate and report federal taxes.  Organizations exempt from federal tax were not spared from these changes.  One change that could result in significant unrelated business income tax (“UBIT”) and/or operational burdens on exempt organizations is the change in the manner in which exempt organizations must calculate certain taxable income and the resulting UBIT.

Prior to January 1, exempt organizations aggregated their unrelated trade or business income from all sources and applied aggregate net operating losses to calculate the resulting UBIT.  This aggregate approach especially benefited exempt organizations that had multiple unrelated business activities, some of which incurred losses.  

The new tax law requires exempt organizations to calculate and report unrelated business income separately for each unrelated trade or business activity.  No longer will an organization be able to use losses from one activity to off-set gains from another.  This change may result in some exempt organizations paying UBIT for the first time and in other cases paying significantly more UBIT than in the past, notwithstanding the reduction in tax rate that will apply.  In addition, net carryover losses incurred following the law change from one activity only may be applied in the future against the same business activity and are limited to 80% of taxable income from that activity.

Complicating this change is the fact that the Internal Revenue Service (“IRS”) has not defined what constitutes a separate unrelated trade or business activity.  The Second Quarter Update to the IRS 2017-2018 Priority Guidance Plan identifies this topic as an IRS priority for the period ending June 30, 2018.  Exempt organizations should look out for future guidance from the IRS regarding this subject.

Even though there remains uncertainty as to the how unrelated trade or business activities should be separated for purposes of calculating the tax, there are certain things exempt organizations can do now to prepare to report UBIT under the new calculation and reporting requirements.  First, exempt organizations should modify their internal accounting methods immediately to begin tracking and reporting each unrelated trade or business activity and its associated expenses separately.  Exempt organizations should assume that the IRS will require very narrow reporting, because it is always easier to adjust from a narrow to broad reporting regime.

Second, exempt organizations should consider creating a taxable subsidiary for the purposes of conducting all of the organization’s unrelated trade or business activities.  Since taxable entities are not subject to UBIT, the taxable subsidiary would be able to aggregate the gains and losses from trade or business activities in the same manner as an exempt organizations did before the Tax Cuts and Jobs Act.

Third, exempt organizations should review all of their unrelated trade and business activities to determine whether these activities should continue, in light of the new tax regime.  Without the benefit of offsetting unrelated trade or business activity income with losses, it may no longer be viable to continue certain programs.  

Finally, exempt organizations should consult their preferred tax and legal professionals now to understand and prepare for proper calculation and reporting of UBIT.  Waiting until it is time to prepare the required IRS Form 990 may be too late.