Tax reform creates basketing for unrelated business activity
Among the topics introduced in the 2017 Tax Act is basketing, a new practice that isolates unrelated business activities into separate tax units. The practice of using baskets — also called brackets or silos —is effective for years beginning after Dec. 31, 2017. The law doesn’t yet define an activity for this purpose. If the activity generates positive unrelated business income (UBI), tax is owed. If the activity generates a loss, the loss carries forward until the discrete loss activity has offsetting income. Basketing replaces the traditional tax treatment of the income and loss from multiple activities, netting to one bottom-line number.
- Previously: Activity 1 has $10,000 of UBI. Activity 2 has $10,000 of loss. Bottom line: $10,000 minus $10,000 equals $0 of UBI.
- After the 2017 Tax Act: Activity 1 has $10,000 of UBI. Activity 2 has $10,000 of loss. Bottom line: we have $10,000 of income from Activity 1, and the loss from Activity 2 carries over until Activity 2 has income to offset the loss.
- Net effect: A break-even year under the old law turns into $10,000 of net UBI under the new Tax Act.
When coupled with other changes, basketing may cause exempt organizations to consider tax-planning actions to avoid paying additional tax.
The current lack of guidance has raised more questions than answers, such as:
- How broad a unit of business is an activity? For instance, would a lab and pharmacy be the same activity because they’re both carried out in the testing and treatment of healthcare patients?
- Are limited partnership investments (with UBI) held as part of an investment portfolio by an exempt organization each treated as a separate activity? Worse yet, will each of the businesses owned by each limited partnership be treated as separate activities?
- Will each UBI rental activity be treated as separate, or can multiple rentals be treated as one activity?
- Would the UBI from new provisions creating UBI from certain employee parking and transportation benefits be treated as a separate activity?
But wait — there’s more. Basketing is just one of three changes to unrelated business income tax rules under the 2017 Tax Act. In addition, (1) Net operating losses generated after Dec. 31, 2017, will be segregated by activity, carried forward indefinitely, and may only offset future income from that activity up to 80 percent, and (2) for taxpayers taxed as corporations, the tax rate changes from a series of graduated rates between 15 and 35 percent to a flat 21 percent.
When coupled with the other changes, basketing may cause exempt organizations to consider tax-planning actions to avoid paying additional tax. Organizations might consider setting up new taxable for-profit entities or bunching activities among existing entities.
Although the basketing provision is listed expressly as a time-sensitive priority in the IRS Priority Guidance Plan, to date no additional guidance has been provided. Meanwhile, organizations have legitimate questions about whether they need to make estimated tax payments or financial statement accruals. Our advice? Begin preparing now with careful analysis and skillful planning, and if you have questions, give us a call.