Rules Change for Unrelated Business Taxable Income, or “Silos,” for Nonprofits

Morgan Blogs Part 2

IRC Section 512(a)(6) went into effect with the Tax Cuts and Jobs Act of 2017. And when it did, the IRS rules for nonprofits changed for unrelated business taxable income (UBTI). With this IRS update, any unrelated trades or businesses, referred to as “silos,” operated by a nonprofit are not allowed to offset income from another trade or business. Prior to this 2017 change, gross income and deductions from unrelated trades and businesses could be combined for tax purposes. This rule change is meant to provide a clearer picture of an entity’s true financial standing.

Unrelated Businesses Must Be Reported Separately

Here’s a brief example to clarify. Let’s say a nonprofit has two separate income silos, Venture A and Venture B. Both earn taxable income that’s not connected to the organization’s overall philanthropic mission.

Venture A rents a portion of its space for parties and other gatherings. For the year, its taxable profit is $18,000. Venture B prints flyers and advertising materials for various vendors. For the year it has a taxable loss of $3,000. In order to calculate its UBTI, the nonprofit is prohibited from applying the taxable loss to the taxable profit. The two silos must stay separate when reporting for taxes.

How to Classify UBTI

Final regulations were issued by the IRS to IRC Section 512(a)(6) in November 2020. This guidance addresses how to classify unrelated businesses separately. Under this final guidance, nonprofits are to use the North American Industry Classification System (NAICS), which is a two-digit code to distinguish between the unrelated businesses of a nonprofit.

The NAICS code refers to one of 20 broad economic sectors. And it should describe the unrelated business activity – not the overall mission of the NFP.

Why the Changes Matter Now?

The IRC Section 512(a)(6) is originally from 2017 and then addressed again in 2020. So why are accountants still talking about it in 2022? Aren’t those changes “old news”?

The answer – yes and no. Much of IRC Section 512(a)(6) has been implemented for several years. But even the final regulations announced in November 2020 didn’t address the CARES Act. CARES was passed in March 2020 to help businesses during the unprecedented times of Covid and, not surprisingly, complicated accounting procedures.

Even now in 2022, we – accountants, auditors and nonprofits – are waiting for official guidance from the IRS, as well as other financial and accounting regulatory entities, on Covid relief acts. Hence, this article and our sincere offer to stay abreast of the changes…while you run your nonprofit.

Assistance with Calculating UBTI

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