IRS issues proposed regs on UBTI ‘siloing’ rules


The IRS published proposed regulations (REG-106864-18) related to the “siloing” rules for unrelated business taxable income (UBTI) on April 24.

The Tax Cuts and Jobs Act (TCJA) added rules in Section 512(a)(6) requiring tax-exempt organizations subject to the unrelated business income tax (UBIT) to calculate their UBTI separately with respect to each trade or business. The proposed regulations build on prior guidance issued in Notice 2018-67, significantly clarifying and simplifying application of the new siloing rules. They also offer eagerly sought guidance on the treatment of certain foreign dividend income for UBTI purposes. The proposed rules are not effective until final. However, taxpayers may rely on either Notice 2018-67 or the proposed regulations for taxable years beginning before the date the final regulations are published, so long as they do so reasonably and in good faith.

The guidance provides welcome relief with respect to unrelated business income reporting. Organizations should determine whether the new UBTI classification rules offer an opportunity to increase available net operating losses (NOLs) and recover taxes by amending returns to aggregate previously siloed activities. They should also re-visit the analysis of their investment activities, particularly with new tests for qualified partnership interests in force. These tests not only impact the organization’s reporting of current investment activities, but also should be considered as a part of investment decisions going forward.




The TCJA modified the manner in which tax-exempt organizations compute their unrelated business income. Under new Section 512(a)(6), a tax-exempt organization with more than one unrelated trade or business can no longer aggregate those activities together to compute its unrelated business income tax (UBIT). Instead, it is now required to calculate UBTI separately with respect to each trade or business, but Section 512(a)(6) provides no definitional guidance on what is considered a “separate trade or business” or how taxpayers should classify certain investment activities.

Notice 2018-67, released on Aug. 21, 2018, offered initial guidance and requested comments on possible methods for the siloing of unrelated trades or businesses. The notice permitted tax-exempt organizations to make a “reasonable, good faith” interpretation of what constituted a separate unrelated trade or business and offered the North American Industry Classification System (NAICS) six-digit codes as an acceptable methodology of determining appropriate silos. The notice also addressed the interaction of the “siloing” rules with the Section 512(a)(7) qualified transportation fringe benefit provision, but that provision was retroactively repealed in December 2019.


Use of NAICS codes


The proposed regulations provide that an exempt organization should continue to separate trades or businesses using the NAICS code system but applying only the first two digits. The NAICS six-digit coding system encompasses many different business activities that do not conform to the traditional business activities of a tax-exempt organization. The simpler, two-digit coding system represents general categories of economic activity, reducing the hundreds of potential “silos” for unrelated business activities to 20 broader sectors, such as retail, real estate and rental, educational services and accommodation and food services.

The proposed regulations further clarify:

  • A NAICS sector code is used only once to report activities on Form 990-T. An organization that conducts the same unrelated trade or business in two different geographies would aggregate those activities into one silo for Form 990-T purposes (assuming they fall under the same NAICS two-digit code). For example, a hospital system with multiple retail pharmacy operations will report all the pharmacies using the NAICS two-digit code for retail trade (44) along with any other retail trade or business it might operate, even if such retail sales are not pharmaceutical sales.
  • Once a NAICS code is assigned to a particular UBTI activity, the organization may not change it to another two-digit code unless it can be shown there was an unintentional error and another code would be more accurate. This limitation applies to the code reported on the first Form 990-T filed after final regulations under Section 512(a)(6) are published.
  • The selected NAICS code aligns with the specific UBTI activity conducted and not the organization’s substantially related exempt activity. For example, a college or university cannot choose the educational services code for its UBTI activities.

Grant Thornton Insight: The proposed regulations provide much-needed clarity and simplification for organizations looking to silo their unrelated business income trades or businesses. The two-digit NAICS code system reduces the potential subsets of UBTI to 20 classifications, thereby enabling organizations to categorize activities into practical silos. Most organizations should see a reduction in their tax compliance burden as there should be fewer silos for which there is a need to segregate and track separate NOLs. The proposed regulations promote a uniformity of approach across not-for-profit sectors and ensure that all organizations are adopting similar approaches.

Organizations should review their current UBTI classification methodology to adapt their reporting to the broad classifications required by the two-digit methodology. This may offer an opportunity to amend previously filed Forms 990-T to aggregate activities that may have been siloed separately on the 2018 return. Not only may an organization increase its available NOLs, it could potentially recover taxes on a profitable business line that would have generated a loss under the current siloing guidance.


Investment activities


Many tax-exempt entities generate significant revenues from various disparate investment activities, including interest, dividends, royalties, rental income, and limited partnership investment income. This revenue is usually excluded from the definition of unrelated trade or business because it is passive. When a tax-exempt organization employs a debt instrument to purchase the assets generating the investment income, these otherwise passive revenue streams become UBTI under the debt-financing provisions of Section 514.

The proposed regulations address the treatment of revenue items as identified in Sections 511 through 514:

  • Unrelated debt-financed income under Section 512(b)(4)
    The proposed regulations provide that income from debt-financed properties are generally held for investment purposes and therefore can be included in the investment activities silo. This means that debt-financed interest, dividends, royalties and rental income can be included in one silo. Nevertheless, the term “debt-financed property” does not include any property that is already included in UBTI as the rental of real or personal property. This rental income should be identified separately as UBTI using the NAICS two-digit code for real estate rental and leasing.
  • Specified payments from controlled entities under Section 512(b)(13)
    Rents, royalties, annuities and interest derived by a controlled subsidiary may not be aggregated into the same silo as the other passive revenue streams identified above. The proposed regulations permit an exempt organization to aggregate all specified payments received from a controlled entity in a single silo. However, specified payments from multiple controlled entities cannot be aggregated, as each controlled entity would be reported in its own individual silo.
  • Certain amounts derived from foreign corporations under Section 512(b)(17)
    Insurance income from all controlled foreign corporations will be treated as one unrelated activity under the proposed regulations. This does not include commercial-type insurance activities conducted directly by an exempt organization (which should already be in its own separate silo).
  • S corporations
    Under Section 512(e), all income received from an S corporation, (including gain or loss on its disposition) is treated as UBTI. The proposed regulations provide that each S corporation interest will be treated as an interest in a separate trade or business and all income from that S corporation will be included in one silo. In addition, similar to the rules provided below for QPIs, S corporation interests that satisfy the de minimis or control tests will be deemed “qualifying S corporation interests” and may be combined with other investment activities.
  • Qualified partnership interests (QPI)
    To the extent a tax-exempt organization invests in a partnership that is deemed to be a QPI, the income from that investment may be aggregated with other investment income. However, given the complexity of the QPI rules, the changes effectuated to QPIs are discussed in the next section.




The proposed regulations adopt the definition of QPIs contained in Notice 2018-67 with favorable modifications to the aggregation of interests and the control requirements. In general, to be considered a QPI, the exempt organization cannot be a general partner of the partnership for any federal tax purpose and must meet either the “de minimis” or “control” test outlined below. The designation of a partnership interest as a QPI and subject to aggregation with other investment activities is permitted but is not required under the proposed regulation. However, once an interest is designated as a QPI, it must retain that designation until it no longer qualifies under the two tests provided below.


De minimis test


The tax-exempt organization may not hold more than 2% of the partnership’s profit or capital interest (the exempt organization may rely on the Schedule K-1 for this information) in order to meet the de minimis test. In a favorable change from Notice 2018-67, exempt organizations are no longer required to combine the interests of a disqualified person (generally officers, trustees, substantial contributors and their relations and related entities) when calculating the 2% threshold. However, the interests of both supporting organizations and controlled entities must still be considered.

When a tax-exempt organization owns an interest in a tiered-partnership structure (i.e. the partnership it owns, in turn, invests in other partnerships), the proposed regulations provide a “look-through rule” when applying the de minimis test. If an exempt organization owns a non-QPI (“UTP”) because it holds in excess of 20% of the capital interest (but does not have control), any lower-tier partnership (“LTP”) interest owned by UTP may itself constitute a QPI if that indirect interest of the exempt organization in the LTP meets the de minimis test. For example, if an organization holds 25% of an upper-tier partnership and its share of the LTP’s profit and capital interests does not exceed 2%, it may apply the de minimis test and include the unrelated business activities of the lower-tier partnerships in the investment activities silo. Obtaining this information at the lower-tier partnership level may be difficult and impractical.


Control test


The tax-exempt organization must hold no more than 20% of the capital interest of the partnership and cannot have control over the partnership in order to meet the control test. The proposed regulations eliminate the concept of “influence” over the partnership that was originally included in this test. If a tax-exempt organization could influence the partnership, the control test was deemed to have been met. However, since the concept of “influence” was so nebulous and difficult to define, the proposed regulations completely remove it.

While control is always governed by facts and circumstances; the proposed regulations provide four additional circumstances that indicate control:

  • An organization by itself may require the partnership to perform, or prevent performing, any act that significantly affects the operations.
  • An organization has the power to appoint or remove officers, employees or a majority of directors.
  • An organization’s officers, directors, trustees, or employees have rights to participate in management.
  • An organization’s officers, directors, trustees or employees have rights to conduct the partnership’s business.

Lastly, Notice 2018-67 provided transition rules for partnerships that do not meet the requirements of a QPI. These partnerships can each be treated as a separate silo (no need for a look-through to assign a NAICS code) and partnership interests acquired before Aug. 21, 2018, may continue to meet the transition rule, even if the percentage interest changes after that date. The transition rule will extend until the adoption of final regulations. An organization may rely on the transition rules only until the first date of the organization’s first tax year beginning after the date of the final regulations’ publication.

Grant Thornton Insight: The proposed regulations represent considerable additional flexibility from the guidance issued in Notice 2018-67. Allowing tax-exempt organizations to silo all investment activities into one bucket is a recognition that most organizations do not treat their passive investment activities as a separate trade or business and that the character of such revenue is functionally the same. Simplification of both the de minimis and control tests should enable tax-exempt organizations to more adeptly comply with the spirit of the siloing rules.

Notwithstanding these improvements, additional work is still needed to reduce the tax compliance burden of tax-exempt organizations invested in dozens (to hundreds) of partnerships. Requiring organizations to trace revenue and compute their capital and profit interest percentages through various tiers of sub-partnerships is likely challenging since those partnerships may be many tiers deep with fund managers unable to provide the necessary support as to ownership and control. Prospectively, exempt organizations and their partnership investments should consider siloing when making their investment decisions. In light of the difficulty of tracing revenue through tiered-partnership structures, tax-exempt investors may want to consider the pros and cons of investing in onshore or offshore blockers.


Allocation of expenses



The proposed regulations make no changes to the generally accepted rules around allocating expenses to unrelated business activities. Organizations may claim a deduction for expenses that are “directly connected” with a particular trade or business (i.e., they have a proximate and primary relationship to that activity). When such expenses relate to more than one activity, the organization must use a reasonable allocation method.

The IRS refrained from providing guidance on the allocation of indirect expenses between an exempt activity and an unrelated trade or business, although it reaffirmed that the gross-to-gross method of allocating expenses is impermissible. The gross-to-gross method of allocation will typically not meet the "proximately and primarily related" test or the "reasonableness" test since the method allocates expense items to unrelated trade or business without regard to their connection to any business activity. The gross-to-gross method uses a ratio of gross income from UBTI over the total gross income from all activities generating the same indirect expenditures. The IRS views such an allocation as an apples-to-oranges comparison.

The IRS intends to publish additional guidance on expense allocation methodologies at a later date.


Other considerations


Charitable contributions


The proposed regulations confirm that a charitable contribution deduction should be applied after considering the bucketing of all UBTI activities. With the 2018 Form 990-T, taxpayers were permitted to take the charitable contribution deduction before applying pre-TJCA NOLs. The 2019 Form 990-T disallows (and corrects) this, and the proposed regulations confirm this treatment. Further guidance is still needed as it relates to the ordering rules of NOL carryover and excess charitable contributions.




The proposed regulations clarify that the language of Section 512(a)(6) does not alter the general NOL ordering rules under Section 172. Organizations that have generated both pre-2018 NOLS (NOLs prior to silo requirements) and post-2017 NOLs (NOLs post-siloing) should deduct the pre-2018 NOLs first. This clarification allows for the maximization of pre-2018s NOLs in a taxable year, as those may be used to offset 100% of taxable income from all silos, whereas a post-2017 NOL may only offset 80% of the silo that generated the loss (subject to temporary modifications due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act).

Grant Thornton Insight: The IRS acknowledges that the CARES Act temporary modifications to the NOL carryback and 80% income limitation rules create a unique juxtaposition with the TCJA rules. The IRS is considering the CARES Act changes to NOLs and how they impact the calculation of UBTI and has indicated that additional guidance on this matter may be issued.

Public support test


When calculating the public support test for Sections 509(a)(1) and 170(b)(1)(A)(vi) and Section 509(a)(2) organizations, the siloing rules of Section 512(a)(6) can be ignored. The organization can aggregate net income and net losses from all UBTI activities (as it historically would have done pre-TCJA). The IRS recognizes that requiring two different calculation methods for UBTI and public support purposes is a burden on exempt organizations. As such, it is requesting comments on the impact of Section 512(a)(6) to the public support test.




The proposed regulations add a new paragraph clarifying that the definition of a trade or business applies to Individual Retirement Accounts (IRA). While most IRAs typically generate their revenues from investment activities, they still must apply Section 512(6) to determine if they have more than one unrelated business activity.


Subpart F income and GILTI


Many tax-exempt organizations invest directly, or indirectly via limited partnerships or hedge funds, in controlled foreign corporations (CFCs). When a tax-exempt organization owns a controlled foreign corporation, it may be subject to the provisions of Subpart F. Subpart F provisions eliminate deferral of U.S. tax on some categories of foreign income by taxing certain U.S. persons currently on their pro rata share of such income earned by the CFC. Subpart F operates by treating the shareholders as if they had received a distribution from the CFC. Similarly, Section 951A requires a U.S. shareholder of any CFC for any taxable year to include in gross income the shareholder’s global intangible low-taxed income (GILTI) for such taxable year in a manner similar to a Subpart F inclusion.

Consistent with Notice 2018-67, the proposed regulations re-affirm the IRS’s long-standing treatment of Subpart F income when earned by tax-exempt organizations. The proposed regulations clarify that Subpart F and GILTI income is treated in the same manner as dividends for purposes of Section 512(b)(1). Dividends are generally excluded when determining unrelated business taxable income. However, this exclusion does not apply to income derived debt-financed property.


Social clubs, VEBAs and SUBs


Due to the unique nature of the UBTI recognized by social clubs, Voluntary Employee Benefit Associations, and Supplemental Unemployment Benefits Trusts, the proposed regulations provide specific guidance on how they should determine if they have more than one unrelated trade or business in the same manner as other exempt organizations. However, investment activities can include interest, dividends, royalties, rental and capital gains that are generally excludable for other organizations that are includable for these organizations. For social clubs, the proposed regulations provide that each nonmember activity must be included as a separate silo.


Next steps


The proposed regulations provide welcome relief to organizations struggling with their unrelated business income reporting. Former guidance under Notice 2018-67 provided a facts and circumstances test to separate revenue streams into silos. The new NAICS two-digit system is administrable by exempt organization and provides the standardization and certainty the IRS was seeking. Organizations should re-visit the analysis of their investment activities now that the new de minimis and control tests are in force. These tests not only impact the organization’s reporting of current investment activities, but also should be considered as a part of investment decisions going forward. As is evident with several of the above issues, the IRS is still seeking comments on certain matters, which will not be settled until the final regulations are issued.

To learn more visit





Tax professional standards statement

This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.


More alerts