Notice 2018-67 Guidance On Code Section 512(a)(6)

TruNorthFeatured News

Featured News

IRS Releases Notice 2018-67 Guidance on Separating UBI Activities

The IRS released Notice 2018-67 last week to provide interim guidance on newly-enacted Code Section 512(a)(6) which requires tax-exempt organizations to compute unrelated business income (UBI) separately for each unrelated trade or business.  This provision is generally effective for tax years beginning after December 31, 2017.  Previously, organizations were permitted to combine the income and loss from all unrelated activities and pay tax on the combined net income (or realize an overall loss) from all activities.

In Notice 2018-67, the IRS has stated that it intends to issue Regulations under Section 512(a)(6), but it has provided guidance for taxpayers to use until such Regulations are issued.  This guidance covers UBI from investment partnerships, the use of NAICS codes for identifying separate trades or businesses, and other areas.

Investment Partnerships

Many tax-exempt organizations were concerned with tracking separate trades or businesses conducted in so-called alternative investments.  Such alternative investments include hedge funds, private equity funds, venture capital funds, and the like.  These investments often operate as flow-through partnerships or limited liability companies (LLC’s), and the tax-exempt investor is deemed to be engaging in all of the trades or businesses of each partnership for purposes of determining UBI.

Tracking multiple trades or businesses within investment partnerships or LLC’s would be extremely burdensome, and thankfully, the IRS has provided interim relief from this burden.  Notice 2018-67 permits taxpayers to aggregate gross unrelated income and associated deductions from investment partnerships into one trade or business for purposes of new Code Section 512(a)(6).  To qualify for this treatment, an exempt organization must meet the requirements of either the de minimus test or the control test.

De minimus Test

An exempt organization will satisfy this test if it holds directly no more than 2% of the profits interest and no more than 2% of the capital interest in an investment partnership.  Organizations can rely on information listed on the Schedule K-1 from the partnership.  In Part II, Item J of Schedule K-1, the partnership is required to list each partner’s share of profit, loss, and capital interests at the beginning and the ending of the partnership’s taxable year.  The de minimus test requires tax-exempt organizations to compute the average of their percentage interests at the beginning and end of the year.  This average interest is then compared against the required 2% threshold for both profits and capital interests.

When determining an exempt organization’s partnership percentage interest, the interest of a disqualified person, a supporting organization, or a controlled entity must be taken into account.  Thus, if the exempt organization’s average profits interest is 1.8% and its supporting organization has an average profits interest of 0.4%, the combined total of 2.2% will exceed the amount permitted under the de minimus test.

Control Test

If an organization fails either (or both) of the requirements under the de minimus test, it may be able to meet the control test.  This test requires that the exempt organization hold no more than 20% of the capital interest in the partnership and not have control or influence over the partnership.  For purposes of the capital interest portion of this test, the above rules for including the interests of disqualified persons, supporting organizations, and controlled entities also apply.  Organizations can rely on Schedule K-1 disclosures of capital interests, and the averaging method described above must also be used.

Per Notice 2018-67, “(a)n exempt organization has control or influence if the exempt organization may require the partnership to perform, or may prevent the partnership from performing, any act that significantly affects the operations of the partnership.  An exempt organization also has control or influence over a partnership if any of the exempt organization’s officers, directors, trustees, or employees have rights to participate in the management of the partnership or conduct the partnerships’ business at any time, or if the exempt organization has the power to appoint or remove any of the partnership’s officers, directors, trustees, or employees.”

Transition Rule

The IRS acknowledges that it may be difficult for exempt organizations to modify ownership percentages and operating agreements to meet the de minimus test or the control test.  As such, the IRS has provided a transition rule for a partnership interest acquired prior to August 21, 2018.  Under this rule, an exempt organization may treat each such partnership interest as comprising a single trade or business for purposes of Section 512(a)(6) whether or not there is more than one trade or business directly or indirectly conducted by the partnership or any lower-tier partnerships owned by the partnership.

Use of NAICS Codes

For determining a trade or business activity outside of the realm of investment partnerships, the IRS will allow an exempt organization to use the North American Industry Classification System’s (NAICS’) 6-digit codes.  The Notice provides this example: under a NAICS 6-digit code, all of an exempt organization’s advertising activities and related services (NAICS code 541800) may be considered one unrelated trade or business activity, regardless of the source of the advertising income.

Notice 2018-67 also states that the IRS wants to set forth in Proposed Regulations a more administrable method than a facts and circumstances test alone for identifying separate trades or businesses for purposes of Section 512(a)(6).  According to the Notice, using a facts and circumstances approach will undoubtedly increase the administrative burden on exempt organizations, lead to inconsistency across the exempt organization sector, and increase the oversight and enforcement burden for the IRS.  No further details about a proposed methodology were in the Notice.

Other Guidance

The income from partnership interests permitted to be aggregated under the rules above includes any unrelated debt-financed income (within the meaning of Code Section 514) that arises from the partnership, so long as either the above de minimus test or control test is met.

Notice 2018-67 references the UBI from qualified transportation benefits under Section 512(a)(7), which includes mass transit and parking benefits provided to employees.  Unfortunately, the Notice gives no guidance on computing the amount of unrelated revenue.  But, it does state that the IRS does not believe that the provision of qualified transportation fringe benefits is an unrelated trade or business.  Thus, the provisions of Section 512(a)(6) do not apply, presumably meaning that the unrelated revenue is taxable in and of itself.

The Notice requests comments from the public on all of these issues as well as the effect of the net operating loss (NOL) rules changes in Code Section 172.  The IRS states that it is seeking comments on how the NOL deduction should be taken by exempt organizations with more than one trade or business and, in particular, by organizations with both pre-enactment (pre-2018) and post-enactment (post-2017) NOL’s.


Notice 2018-67 is largely favorable to exempt organizations, particularly those with investment partnerships.  Prior to the release of this guidance, many of us were concerned that we would have to treat the income or loss from each alternative investment separately rather than aggregating them into one net income/loss amount.  It is encouraging to find that the IRS realized the tremendous burden associated with separately tracking investment entities’ UBI.

However, implementing the provisions of Notice 2018-67 and tax reform in general is still very challenging for the exempt organization sector.  We still lack guidance in significant areas including calculating the amount of unrelated revenue from qualified transportation benefits, a provision that could affect virtually every tax-exempt organization in the U.S.  We will continue to monitor developments in these areas and communicate guidance as soon as we receive it.  If you have questions about this article or tax reform’s effects on not-for-profit organizations in general, please contact Chris Anderson at 216-344-5268 or at