The IRS Issues Proposed Unrelated Business Income Silo Rules

Favorable proposed tax rules were issued on April 23, 2020 for tax-exempt organizations that have more than one unrelated trade or business activity. These new rules are complex, so this article will aim to both define these new rules and explain why they are beneficial to tax-exempt organizations.

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Favorable proposed tax rules were issued on April 23, 2020 for tax-exempt organizations that have more than one unrelated trade or business activity. These new rules are complex, so this article will aim to both define these new rules and explain why they are beneficial to tax-exempt organizations.

Favorable proposed tax rules were issued on April 23, 2020 for tax-exempt organizations that have more than one unrelated trade or business activity.

These new rules are complex, so this article will aim to both define these new rules and explain why they are beneficial to tax-exempt organizations.

Overview: Unrelated Business Income “Silo” Rules

Section 512(a)(6) of the Internal Revenue Code was enacted as part of the Tax Cuts and Jobs Act (TCJA) at the end of 2017. It requires exempt organizations with more than one unrelated trade or business to calculate unrelated business taxable income (UBTI) separately for each trade or business and doesn’t allow losses from one unrelated business activity to offset income from another. These are often called the unrelated business income (UBI) “silo” rules.

The Department of Treasury and Internal Revenue Service recently issued significant proposed regulations to provide guidance and bright lines regarding the UBI silo rules.

The IRS had previously asked for comments when it issued interim guidance in Notice 2018-67 (the Notice) in August 2018.

The proposed regulations recently issued are responsive to commentators and provide greater certainty to tax-exempt organizations on how to calculate the tax. They help ensure consistent treatment by exempt organizations that are similar in nature but might otherwise make different reasonable, good-faith assumptions on how to calculate UBTI. Plus, they are more administrable for the IRS.

How will these new rules impact tax-exempt organizations?

There are two beneficial changes included in these new rules that we’ll cover below: 1) The allowance of two-digit NAICS codes, and 2) the requirement to combine interests of disqualified persons.

Two-Digit NAICS Codes

Let’s start with the coding system.

One of the most important provisions in the proposed regulations is the requirement to use the first two digits of the North American Industry Classification System (NAICS) codes for identifying separate unrelated trades or businesses. The IRS Notice had originally suggested use of the NAICS six-digit coding system, but the U.S. Treasury and the IRS decided to allow two-digit codes.

Why is this important? It’s simple: Instead of having to sift through more than 1,000 different 6-digit industry codes, exempt organizations will only have 20 industries to choose from to group and report separate UBI activities. These much broader categories allow for more aggregation of activities.

The 20 two-digit codes can be found on pages 26 through 76 in the NAICS Manual. For example, hotel operations and restaurant activities are now grouped together as one activity using the 2-digit NAICS code (72) and different types of recreational activities, such as fitness centers and golf courses, are grouped together using the 2-digit NAICS code (71), rather than separate 6-digit codes.

For your convenience, we’re also listing them here:

  1. Agriculture, Forestry, Fishing, Hunting (11)
  2. Mining, Quarrying, Oil & Gas Extraction (21)
  3. Utilities (22)
  4. Construction (23)
  5. Manufacturing (31-33)
  6. Wholesale Trade (42)
  7. Retail Trade (44-45)
  8. Transportation & Warehousing (48-49)
  9. Information (51)
  10. Finance and Insurance (52)
  11. Real Estate and Rental & Leasing (53)
  12. Professional, Scientific & Tech Services (54)
  13. Management of Cos. & Enterprises (55)
  14. Administrative and Support (56)
  15. Educational Services (61)
  16. Health Care and Social Assistance (62)
  17. Arts, Entertainment & Recreation (71)
  18. Accommodation & Food Services (72)
  19. Other Services (81)
  20. Public Administration (92)

Common unrelated business activities for tax-exempt organizations include, among many others, advertising; retail activities like bookstores or gift shops; facilities rentals; events like conferences and weddings; parking; catering; and sports camps. Many of the 20 NAICS codes likely won’t apply to tax-exempt organizations while some of the broad 20 categories might result in strange combinations. For example, taxable laundry services and taxable parking would be combined as one unrelated business income silo. Overall, use of these 20 industry categories should make it easier for exempt organizations to comply with the silo tax rules.

To prevent inappropriate reclassifications, once an exempt organization has identified a separate unrelated trade or business using a particular two-digit code, it may not change the code unless the organization can show it inadvertently chose an incorrect code or another one more accurately describes the trade or business.

The proposed regulations also clarify that each NAICS 2-digit code is to be reported only once. This means, for example, a hospital system that has multiple facilities with UBI from non-patient pharmacy sales at each location would use one code for all of the retail business (44) rather than treating each pharmacy as a separate trade or business.

Investment Activities – Combining Interests of Disqualified Persons

The next beneficial rule change applies to organizations’ investment activities – and should be welcome news for executives of exempt organizations with endowments and alternative investments, as well as their board members, officers, and substantial donors.

The 2018 IRS Notice had originally provided rules for exempt organizations to aggregate UBI generated from investment partnership interests that meet either the de minimis ownership test (up to 2%) or the control test (up to 20% and with no control). This allows exempt organizations to offset the losses generated by their qualifying partnership interests with income generated by other qualifying partnership interests.

To calculate these ownership percentages, the prior guidance required exempt organizations to combine the partnership interests owned by disqualified persons (that is, board members, officers, substantial donors, their family members and related companies), along with the exempt organizations’ ownership interests. The proposed regulations removed this requirement! As you can imagine, this is a great relief for exempt organizations to no longer have the burden of obtaining this sensitive information from their board members and other disqualified persons.

The proposed regulations in general have otherwise kept the 2% de minimis and 20% control tests, with some modifications.

How do these new rules define “Investment Activities?”

The proposed regulations provide an exclusive list of “investment activities.” They allow certain investment activities to be aggregated as one activity for UBI silo purposes for administrative ease rather than requiring NAICS codes for each activity. The exclusive list of investment activities includes:

  1. Qualifying partnership interests
  2. Qualifying S corporation interests; and
  3. Debt-financed property or properties

Let’s go deeper into each of these categories.

Qualifying Partnership Interests

A partnership interest that meets either the 2% de minimis test or the 20%/no control test is a Qualifying Partnership Interest (QPI) as long as the exempt organization is not a general partner.

The 2% de minimis test means the exempt organization holds no more than 2% of the profits interest and no more than 2% of the capital interest. The 20%/no control test is met if no more than 20% of the capital interest is held in a partnership over which the exempt organization partner has no control. Exempt organizations may rely on the Schedule K-1 if it reports the applicable percentages.

The proposed regulations attempt to provide a bright line, but Treasury and the IRS indicate that all facts and circumstances may be considered in determining whether an exempt organization controls a partnership. A partnership agreement may be considered along with these factors:

  1. The exempt organization, by itself, may require the partnership to perform, or may prevent the partnership from performing any act that significantly affects the partnership’s operations;
  2. Any of the exempt organization’s officers, directors, trustees, or employees have rights to participate in the management of the partnership at any time;
  3. Any of the exempt organization’s officers, directors, trustees, or employees have rights to conduct the partnership’s business at any time; or
  4. The exempt organization, by itself, has the power to appoint or remove any of the partnership’s officers or employees or a majority of directors.

If an exempt organization holds greater than 20% of the capital interest of a partnership, the proposed regulations don’t allow aggregation of a non-QPI with the other investment activities. The exempt organization would have to determine the NAICS code for each unrelated business activity that flows through the non-QPI as reported on its Schedule K-1 from the partnership.

Treasury and the IRS indicate in the preamble that “… an exempt organization’s investment intent is not sufficient to treat the overall non-QPI as part of its investment activities.”

However, if the partnership is not a QPI because it doesn’t meet the 20% test, and as long as it’s not controlled by the exempt organization, there is a special rule that allows any lower-tiered de minimis indirectly held partnerships of that non-QPI to be aggregated with the investment income. This may be very beneficial to any applicable fund-of-funds.

Qualifying S corporation interests and debt-financed income

Qualifying S corporation (QSI) and debt-financed investment income may also be aggregated with the overall investment activities, according to the new UBI silo rules.

Non-QPIs, interests in S corporations that exceed the 2% or 20% stock ownership thresholds, and specified payments from controlled entities are not treated as part of the favorable aggregated investment income.

The proposed regulations include special transition rules for partnership interests acquired prior to August 21, 2018 that are not QPIs (non-QPIs). The multiple sources of UBI from an exempt organization’s non-QPI may be combined as one unrelated business activity from that entity, at least until the final regulations are issued.

For example, if an exempt organization has two non-QPIs under this transition rule, regardless of the number of UBI sources in each partnership, it may treat them as two separate trades or businesses, one from each entity. Under the proposed regulations, exempt organizations may also aggregate all UBI generated from a single non-QSI as one separate unrelated trade or business. If an exempt organization holds interests in multiple non-QSI entities, each non-QSI entity would be treated as a separate trade or business.

Similarly, exempt organizations may aggregate specified payments from a single controlled entity as one unrelated trade or business. Likewise, if an organization has two controlled entities that make multiple types of specified payments to the exempt organization, it may treat them as two separate trades or businesses, one from each entity.

What else do exempt organizations need to know about these new rules?

Before we wrap, let’s just quickly run through a few additional general topics that tax-exempt organizations should keep in mind.

How have these new rules impacted expense allocations?

The Treasury and IRS acknowledge the long-standing challenges exempt organizations face with allocating deductions to reduce the income from those separate trades or businesses.

The existing rules say that to be “directly connected” with a trade or business, the deduction item must have a “proximate and primary” relationship to carrying on the activity. Exempt organizations may have items of deduction that are shared between an exempt activity and unrelated trade or business.

In simpler terms, the allocation must be done on a reasonable basis. However, what is “reasonable” depends on facts and circumstances, which is not easy for the IRS or taxpayers to administer.

The regulations say that the use of unadjusted gross-to-gross revenue method is not a reasonable allocation. The example provided is a school that operates a ski facility used for its education program (related purpose) and also for public recreation (an unrelated purpose). If a higher price is charged for public use than for educational student use, it’s unreasonable to allocate costs based on the percentage of revenue from each use. This would overstate the tax deductions against UBI. It’s also often unreasonable to allocate expenses to different activities on this method.

The preamble to the proposed regulations indicates the Treasury Department and IRS continue to consider the expense allocation rules and relying “solely on reasonableness is difficult for the IRS to administer and may not provide certainty for taxpayers.” They continue to study the expense allocation issue and plan on providing further guidance in a separate notice.

Net operating loss ordering

The proposed regulations clarify that pre-2018 net operating losses (NOLs) should be used prior to post-2017 NOLs, as expected. Shortly before these proposed regulations were published, Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) which changed some of the post-2017 net operating loss rules. The Treasury and IRS indicated they will consider how these changes affect UBTI and may issue additional guidance.

What’s Next?

Request for Comments

The Treasury Department and IRS are currently requesting comments and feedback on various topics throughout the proposed regulations, not limited to, but including:

  • Identification of better or additional methods to the 2-digit NAICS codes;
  • Permitting change to NAICS 2-digit codes;
  • Expense allocation methods;
  • Specific factors to be considered in determining if an activity is an investment activity;
  • If any permitted rights or actions should be disregarded in the control test for QPIs;
  • Allowing aggregation of lower-tiered partnerships that meet the de minimis test;
  • Need for any additional transitional relief;
  • Net operating loss carryover ordering;
  • Application of the UBI silos to the public support test.

Comments that were provided in response to the interim Notice 2018-67 were clearly taken into consideration for the issuance of these well-thought out proposed regulations. It is expected that further comments from the exempt organization community and tax community will also be carefully considered in the promulgation of the final regulations.

Written or electronic comments are due by June 23, 2020 and may be submitted at

Form 990-T

The public will also have an opportunity to comment to any updates the IRS makes to Form 990-T, related schedule and instructions.

Effective Date and Reliance

These proposed regulations will apply to tax years beginning on or after they are published as final regulations.

In the meantime, exempt organizations may rely on any of the following:

  • A reasonable, good-faith interpretation of Internal Revenue Code sections 511 through 514, considering all of the facts and circumstances when identifying separate unrelated trades or businesses;
  • Methods of aggregating or identifying separate trades or businesses as provided in Notice 2018-67; or
  • These proposed regulations in their entirety.

Many believe that these UBI silo provisions are unfair and unnecessarily burdensome to nonprofits and some nonprofit associations have asked Congress to suspend the rules.

blumshapiro is pleased to help tax-exempt organizations understand, address and strategize how to best manage the new UBI rules and favorable proposed rules. We will continue to update the tax-exempt community on these tax developments.

Laura J. Kenney, CPA, MST is a tax principal with blumshapiro, the largest regional business advisory firm based in New England, with offices in Connecticut, Massachusetts, Rhode Island and Virginia. The firm, with a team of over 500, offers a diversity of services, which include auditing, accounting, tax and business advisory services. blum serves a wide range of privately held companies, government, education and non-profit organizations and provides non-audit services for publicly traded companies. To learn more visit us at

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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