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Unrelated Business Taxable Income (UBTI)

Unrelated Business Taxable Income (UBTI)

You might think that the only time there would be taxes on an IRA or other type of retirement account would be when you make withdrawals or distributions. However, some income received in retirement accounts, tax-exempt entities, may be taxable before that date.


What is UBTI?

Unrelated business taxable income is income earned by a tax-exempt entity, such as an IRA, unrelated to the tax-exempt entity's goal of exemption. The exempt purpose of an IRA is to provide a pension to the holder of the IRA.

For example, suppose you have an oil drilling company in the IRA, and the drilling equipment owned by the company is leased for use by another company. This rental income would be considered as UBTI.


UBTI tends to be generated by the following types of investments:

• Limited partnership (LP): company owned by several people, with limited liability towards the owners for commercial debts.

• Master Limited Partnership (MLP): A publicly traded limited partnership often found in the energy industry.

When an IRA is invested in an MLP or LP, it becomes a partner in the partnership. This is an ownership interest in the participation. Becoming the owner (in whole or in part) of a business (such as MLP or LP) is not considered under the IRA exemption objective. MLPs and LPs can generate taxable income in a retirement account if the business borrows money, also known as leverage.


Understanding UBTI (Unrelated Business Taxable Income)

Section 501 of the Federal Revenue Code (IRC) grants tax-exempt status to a variety of tax-exempt and mutually beneficial organizations. You may be subject to tax if you engage in unrelated activities and earn income. The Internal Revenue Service (IRS) defines income generated from independent business activities as income from normal business activity that is not substantially related to the underlying purpose of the organization's tax exemption.

Unrelated Business Taxable Income was introduced in 1950 to ensure that tax-free businesses compete fairly with taxable businesses in profit-generating activities.

 In addition, UBTI prevents or restricts tax-exempt entities from engaging in business activities unrelated to their primary objectives. Most forms of passive income, such as dividends, interest income, and capital gains from the sale or exchange of fixed assets, are not treated as UBTI. If an investor has an IRA and is investing in traditional stocks, mutual funds, and ETFs, the UBTI rules are unlikely to apply. However, if the fund generates income qualified as UBTI, the fund may be taxed. For example, a restaurant's income that goes into an IRA is considered taxable and is subject to UBTI tax.

Some transactions that can be considered UBTI include:

  • Buying and selling a significant amount of real estate in one year

  • Conducting business operations, such as restaurants, shops, inns, gas stations, etc., that generates active income and are managed by pass-through entities, such as a limited liability company (LLC) or a master limited liability company (MLP)

  • Make several private loans in a given year.

  • Using margin when buying stocks

Income from qualifying taxable assets is subject to an estimated income tax of up to 37% over $12,750 (in 2019). Form 990-W is a worksheet provided by the IRS to determine the number of estimated tax payments required. An exempt organization that has a gross income of $1,000 or more from an unrelated corporation must file additional fees with the IRS using Form 990-T. An organization must pay an estimated fee if it expects the annual fee to be at least $500


Tax considerations

An IRA is an exempt entity separate from the final beneficiary of the IRA and can be taxed on its own. UBTI is taxable for all types of retirement accounts, such as IRAs, retirement plans, such as Keoghs, and Health Savings Accounts (HSA). When the total positive UBTI for all applicable investments held in a retirement account is equal to or greater than $1,000, Form 990-T must be submitted.


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