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Tax Reform Bill Proposes to Eliminate UBTI Exemption for Government Plans

House bill, if enacted, will alter tax analysis with respect to fund investments.

On November 2, House Republicans released their draft tax reform bill. Of particular interest to government pension plans is a provision buried in the 429-page draft bill that, if enacted into law, would prevent such plans from taking the position that they are not subject to tax on unrelated business taxable income (UBTI) on account of their exemption from tax under Section 115.[1]

As explained by the House Ways and Means Committee, current law provides that income derived from a trade or business regularly carried on by an organization exempt from tax under Code Section 501(a) (including pension plans) that is not substantially related to the performance of the organization’s tax-exempt functions is subject to the unrelated business income tax (UBIT). The explanation goes on to say that “[a] college or university that is an agency or instrumentality of a State government (or political subdivision) generally is subject to UBIT on any unrelated business taxable income. It is unclear, however, whether certain State and local entities (such as public pension plans) that are exempt under Code section 115(l) as government-sponsored entities as well as section 501(a) are subject to the UBIT rules.” The draft bill would amend the provision that addresses which organizations are subject to UBTI to provide that an organization would not be exempt from tax on UBTI solely because the organization is also exempt from tax based on another provision in the Code.[2] Thus, this reform proposal would prevent a government pension plan (described in Section 401(a)) that is exempt from tax under Section 501(a) from claiming an exemption from tax on UBTI pursuant to Section 115 due to its status as a government entity.

The House bill is not the first proposal to eliminate the UBTI exception for government pension plans.[3] While there may be questions concerning the constitutionality and practicality of proposals of this nature, there is a significant possibility that this provision will be reflected in any final tax reform bill. The provision states that it would be effective for taxable years beginning after December 31, 2017. We will closely monitor this proposed bill and notify you of any material developments with regard to the specific provision discussed above. We are also available to discuss approaches to mitigate the impact of UBIT arising from fund investments.

[1] Unless otherwise noted, all “Section” references are to the Internal Revenue Code of 1986, as amended (the Code)

[2] One might make the observation that the need for an amendment to address the application of the UBTI rules to government pension plans might be viewed as a confirmation that under current law such plans are exempt from the UBTI rules due to Section 115.

[3] In 2014, then House Ways and Means Committee Chairman Dave Camp (R-Mich.) included a similar provision in his ultimately unsuccessful draft tax reform bill.

Copyright © 2020 by Morgan, Lewis & Bockius LLP. All Rights Reserved.National Law Review, Volume VII, Number 307


About this Author

Christopher Dlutowski, Morgan Lewis Law Firm, New York, Private Investment Attorney

Christopher J. Dlutowski counsels private investment funds—including US domestic and offshore hedge funds, private equity funds, and funds-of-funds—and investment management firms on forming and structuring funds, trading and other investment activities, raising capital, and ongoing operations. Christopher also represents institutional investors—including governmental and corporate pension plans, universities, family offices, and funds of funds—on their investments in hedge, private equity, and other private funds, managed accounts and co-investments, and advises clients...

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Paul McCoy, Morgan Lewis Law Firm, New York, financial services attorney

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