PLANADVISER - March/April 2019 - 55

compliance consult
Unrelated Taxable
Income and Pensions
'Tax Cuts' act raises the tax on funds generating UBTI
PLAN fiduciaries, plan advisers and investment
fund
managers may not be aware that the Tax Cuts and Jobs Act
of 2017, enacted a year ago December, made major changes
to the Internal Revenue Code (IRC) provisions affecting
unrelated business taxable income (UBTI). The IRS issued
IRS Notice 2018-67 this past August 20, to provide some
guidance on how to interpret these changes to the IRC and
how to apply them until the Treasury Department issues
proposed regulations. Those regulations could have a
substantial impact on how tax-qualified retirement plan
trusts and voluntary employee benefit associations (VEBAs)
invest in funds that generate UBTI and how such funds are
structured and managed.
Plan trusts and VEBAs invest in funds-typically organized
as partnerships or limited liability companies (LLCs)-
that generate UBTI. The trusts and VEBAs are tax-exempt
entities under Sections 501(a) and 501(c)(9) of the IRC, and,
thus, the federal government generally does not tax them
on income unless they generate UBTI. A fund manager
generates UBTI if:
the manager, on behalf of the fund,
purchases or invests in debt-financed property; the fund is
actively engaged in a business, such as the management of
real estate; or the fund invests in a limited partnership that
conducts these activities.
The Employee Retirement Income Security Act (ERISA)
does not prohibit investments that generate UBTI. However,
ERISA fiduciaries should consider the impact of such income
on the plan trust's or VEBA's rate of investment return in
light of the fact that plan trusts and VEBAs are otherwise
tax-exempt organizations.
Prior to the Tax Cuts and Jobs Act, even if a fund generated
UBTI, a plan fiduciary or an adviser could often
manage the impact of that income. In accordance with the
IRC, the plan or VEBA could net gains or losses generated
by one investment fund against the gains or losses generated
by another. Additionally, to the extent a fund generated
net operating losses (NOLs), the plan or VEBA could carry
over those losses to future tax years to deduct against UBTI
generated in a subsequent tax year by the same fund or a
different fund. As a result, many plan trusts and VEBAs
could manage investments in a way that would reduce
the impact of UBTI. For example, the trust or VEBA could
balance its investments between newly formed funds,
which are more likely to generate losses, and mature funds,
which are more likely to generate income.
The act amended IRC Section 512(a)(6) in a manner that
would substantially change a fiduciary's or adviser's ability
to manage UBTI, as described. The tax code now requires
that the trust or VEBA calculate gains and losses of each
" trade or business. " In the absence of regulations or additional
guidance from the Treasury Department or the IRS
providing otherwise, the IRC now appears to require that
a trust or VEBA treat each investment fund as a separate
trade or business. Therefore, the ability to calculate gains
and losses on a net basis is lost. Further, the trust or VEBA
may not use future NOLs generated by one fund to offset
gains generated by another fund.
As a plan fiduciary, an adviser to a plan, or a fund
manager, you should not underestimate the impact of this
development on how you manage plan trusts, VEBAs and
investments funds. As noted above, while ERISA certainly
does not prohibit a plan trust or VEBA to invest in funds that
generate UBTI, plan fiduciaries must consider the impact
of that income on investment performance. The inability
to aggregate and use NOLs, as described, could result in
a substantially higher tax burden and thus may require
reconsideration regarding whether certain UBTI-generating
investments are appropriate. Alternatively, plan fiduciaries
and their advisers may ask managers to structure their
funds, or investments in their funds by a trust or VEBA, by,
for instance, using " blocker " entities so that any UBTI is not
passed through to the trust or VEBA.
The previously mentioned IRS Notice 2018-67 explains
how a trust or VEBA may define a trade or business, as well
as gives some other helpful guidance. For example, the
notice provides that, pending further guidance, the plan
trust or VEBA should apply a " reasonable, good faith interpretation "
of the term " trade or business. " In this regard,
the notice provides for a safe harbor if the trust or VEBA
uses the six-digit code listed in Section 3.03 of the Northern
American Industry Classification System (NAICS).
In summary, the changes to the UBTI provisions of the
tax code will have a substantial impact on plan trusts and
VEBAs. The IRC and Notice 2018-67 are the only authorities
currently available. Fiduciaries, advisers and fund
managers should not expect additional guidance prior to
the date federal income tax returns are due for tax years
beginning in 2018.
David Kaleda is a principal in the fiduciary responsibility practice
group at Groom Law Group, Chartered, in Washington, D.C. He has
an extensive background in the financial services sector. His range of
experience includes handling fiduciary matters affecting investment
managers, advisers,
broker/dealers,
insurers, banks and service
providers. He served on the Department of Labor's ERISA Advisory
Council from 2012 through 2014.
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