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Issue 40138

Silo Rules/NAICS Codes

Project Statement: Prior to the TCJA, all the income of a tax-exempt organization derived from its unrelated trades or businesses was netted with all the losses from such trades or businesses.

Treasury had expressed concern that some tax-exempt organizations may be establishing separate unrelated trades or businesses for the purpose of netting gains from one such business with losses from another and thereby reduce their tax exposure.

Goal Statement: The amended law requires that each unrelated trade or business calculate its gains or losses independently of the other unrelated trades or businesses. This rule now eliminates the access of the netting practice which taxable corporations continue to be able to use. This leaves open the question of which businesses are unrelated for purposes of Code §512(a)(6)(A).

TAP RECOMMENDATION

We propose a three-part approach to establishing an ecology in which guidance grounded in empirical business practice can evolve. By establishment of a reporting process that is transparent and that encourages compliance rather than obfuscation, the IRS can access, in real time, how the tax-exempt community behaves in response to and seeks to comply with this new law.

Compliance, especially for purposes of Code Section 512(a)(6) with respect to interpreting the presence of two or more unrelated trades or businesses could be had by giving taxpayers access to three mechanisms for determining whether a business is “unrelated” for this purpose. For convenience of IRS review and comment, we express these mechanisms as three separate recommendations:

1. The NAICS might provide a reporting safe harbor to exempt organizations reporting UBTI from more than one unrelated trade or business

Together with the following two recommendations, each of the recommended elections, consistently used by each taxpayer, will provide the taxpayer with comfort that its tax positions will not be subject to unexpected penalties arising from a disagreement with the Service over whether a business is “unrelated” and whether its gains or losses ought properly be netted with another unrelated trade or business based on whether it is sufficiently “separate.”

At the same time, using these three approaches, each taxpayer’s position will be fully documented, providing the Service and taxpayers continuously updated access to how the statutory requirements are being interpreted and whether such interpretations are consistent with the purpose of the statute. As well, an ongoing sense of the administrative burdens of compliance will be made available by the filed information.

Recommendation Number Two of Three

2. Tax exempt organizations whose unrelated trades or businesses might not be accurately or adequately distinguished by the NAICS codes could protectively disclose their positions using Form 8275 and thereby avoid certain penalties that could be imposed for merely taking a tax position with which the Service may later disagree. This approach may also serve to provide the IRS with current data regarding how the separate business issue is being addressed by tax exempt enterprises

Recommendation Number Three of Three (SAMS #3)
3. Reliance on a tax professional’s advice on a matter of tax law can serve as “reasonable cause” for failure to timely file and failure to timely pay in circumstances where such reliance can be shown to constitute “reasonable cause.”

a. In situations of late filing or late payment, the IRS considers a delay to be due to reasonable cause if the taxpayer exercised ordinary business care and prudence and was nevertheless unable to timely file or pay. Reg. §301.6651-1(c)
b. The Internal Revenue Manual prescribes that ordinary business care and prudence is generally the level of care that a reasonably prudent person would use in conducting business. See, IRM §20.1.1.3.1.2(1). By contrast, willful neglect is, generally, a conscious, intentional failure to comply with the tax law, or reckless indifference to the law. See, IRM §20.1.2.1.4.1(2)
c. In Estate of Thouron, 752 F.3d 311, 316 (3d Cir. 2014) the Third Circuit identified three types of reliance on an agent in the context of the tax law:

i. Reliance related to the ministerial task of filing returns and paying taxes
ii. Reliance under which a taxpayer files or pays after the actual due date, but within the time erroneously advised by a tax professional and
iii. Reliance on a tax professional’s advice concerning a matter of law

The Service could adopt the third test of Thouron as one on which tax-exempt entities could rely in taking a position regarding the separateness of their unrelated trades or business for purposes of compliance with Code §512(a)(6). The taxpayer in such circumstance could merely state that the taxpayer is relying on the written advice of a tax professional in concluding that the listed trades or businesses are or are not “unrelated” or “separate” for purposes of Section 516(a)(6). Should a challenge ensue, the taxpayer would produce the written advice in support.

IRS Action:TAP reviewing IRS response

IRS Comments

Overview: (1) The recommendation for a safe harbor appears to be responsive to the I.R.B. Notice 2018-67 request for comments; IRS:TE/GE:EO has shared with CC:EEE:EO since this is a matter of legal rule-making.
(2) As discussed, F. 8275 discloses uncertain positions to avoid penalties.
(3) The discussion of reasonable reliance on tax advice appears to be a description of existing rules. To the extent the discussion relates to how separate trades or businesses should be identified, it is responsive to I.R.B. Notice 2018-67 request for comments; IRS:TE/GE:EO has shared with CC:EEE:EO since this is a matter of legal rule-making.

Response to Recommendations: (1) Generally, safe harbors create certainty inside the harbor while leaving uncertainty outside. As indicated above, IRS:TE/GE:EO has shared with CC:EEE:EO since this is a matter of legal rule-making.
(2) While taxpayers are free to file F. 8275, the goal of the rule-making is to clarify the reporting requirements on F. 990-T.
(3) Taxpayers can continue to rely on existing rules. As indicated above, IRS:TE/GE:EO has shared with CC:EEE:EO to the extent this item relates to a matter of legal rule-making.

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2020 TAP Annual Report

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