In addition to finalizing the rule of using NAIC codes for making the determination as to whether an organization has more than one separate unrelated business activity for Form 990-T reporting purposes, which you can read all about here, the IRS Final Regulations (which adds section 512(a)(6) to the Internal Revenue Code) also includes other important information and rules on UBTI. Some of those are summarized as follows:
- If a tax-exempt organization has one or more unrelated business activities to report as taxable on Form 990-T, the organization has to determine expenses allocable to the income generated from those activities. It’s very likely that there may be some shared expenses (such as depreciation, rent or utilities) which can be allocated between both the tax-exempt activities as well as the other activities. However, the IRS does not allow allocation of shared expenses using the “unadjusted gross-to-gross method”. This method is considered unreasonable. Gross-to-gross includes a calculation of one activity’s gross income as a percentage of total gross income, and applying that percentage to a shared expense for allocation purposes. The gross-to-gross method is only unreasonable if it’s “unadjusted”. This is when the sale of goods or services are provided at a reduced/discounted price for one of the activities, but not for the other. In this case, the calculated percentage of income would not be an accurate reflection of the expenses utilized to generate the income.
- The NAIC code(s) used by an organization cannot be changed for each activity in later years unless: (1) The original code used was due to an unintentional error, and (2) another code more accurately describes the activity.
- If a tax-exempt organization has a partnership interest in more than one partnership, and if it’s considered to be a “qualified partnership interest” (QPI), then the organization may group all UBTI from these partnerships together (along with UBTI from S-Corp interests) and classify it as one unrelated investment activity for Form 990-T purposes.
- A QPI is when the tax-exempt organization is not the general partner in the partnership, and has either a de minimis interest (2% or less), or passes the participation test (20% or less interest and does not have control over the partnership, indicated by significant participation).
- If a controlling organization (under 512(b)(13)(d)) receives specified payments (such as rent income) from two or more different controlled entities, each will be treated as separate UBTI activities for Form 990-T reporting purposes.
These IRS Final Regulations on UBTI include much more information and important guidance on the above topics and more, and can be accessed here. If you have any questions about taxable income or other form 990 issues, contact your Henry+Horne advisor.