The draft tax reform bill released by the House of Representatives contains provisions that, if enacted, will affect the unrelated business income tax. While it is uncertain that any tax reform law will be enacted and unlikely that the House bill will be enacted as proposed, we will keep track of the proposed changes affecting the UBIT during the tax reform negotiations.
Note: The tax reform bill is H.R. 1, entitled Tax Cuts and Jobs Act. To read the entire text of the proposed bill, click here.
Application of UBIT to State and Local Entities
Section 501(c) lists numerous categories of exempt organizations that are exempt from income taxes. Notwithstanding the exemptions, most exempt organizations are nevertheless subject to the unrelated business income tax. State instrumentalities are not mentioned in §501(c) but are exempt from taxation under §115. The exemption applies to income derived from a public utility or the exercise of any essential governmental function and accruing to a state or political subdivision thereof, or the District of Columbia.
The UBIT applies to organizations described in §501(a), employer provided pension plans described in §401(a), and state colleges and universities. Because the UBIT expressly applies to state colleges and universities but not to other state instrumentalities, state and local entities, including pension plans, had been thought to be outside the scope of the UBIT.
The proposed House bill specifically states that an organization or trust shall not fail to be treated as exempt from taxation under this subtitle by reason of section 501(a) solely because such organization is also exempt, or excludes amounts from gross income, by reason of any other provision of this title. H.R. 1, §5001(a). Thus, for purposes of the UBIT, state and local entities are treated as described in §501(a) notwithstanding the fact that their income is also excluded under §115.
Limitation on Exclusion for Research Income
Section 512(b)(9) contains an exclusion from UBTI that applies to organizations operated primarily for purposes of carrying on fundamental research the results of which are freely available to the general public. Under present law, such organizations can exclude from UBTI all income from research performed for any person. The requirement that the organization be operated primarily to carry on fundamental research that is made freely available to the general public means that the organization remains eligible for the exclusion when it performs fundamental research that is not made freely available to the general public so long as the primary purpose requirement is met.
The proposed bill would narrow the exclusion to cover only income from research the results of which are freely available to the general public. H.R. 1, §5002(a) Thus, if an organization operated primarily for purposes of carrying on fundamental research with results freely available to the general public performs fundamental research that is not made freely available, income from such research is subject to the UBIT.
The proposed effective date for both amendments is December 31, 2017.