IRAs are subject to the unrelated business income tax

by | Apr 6, 2023

ARTICLE | April 06, 2023

Individual Retirement Accounts (IRAs) described in section 408 are subject to the unrelated business income tax (UBIT) to the extent their gross unrelated business taxable income (UBTI) exceeds $1,000.

IRA fiduciaries generally have the responsibility of filing Form 990-T, Exempt Organization Business Income Tax Return, but the tax liability belongs to the IRA.

What is UBIT?

UBIT is a tax imposed on the unrelated business income of exempt organizations, including IRAs. For IRAs and other trusts subject to UBIT, the trust tax rates apply (reaching 37% at $14,451 of income in 2023).

What is unrelated business income?

For IRAs, any income that is not excluded investment income generally will be unrelated business income. Typically, IRAs earn taxable income through investments in partnerships or LLCs with operating businesses (e.g., private equity funds, hedge funds, venture capital, publicly traded partnerships, and other alternative investment structures).

What is excluded investment income?

There are five common types of income that are statutorily excluded from unrelated business income:
  1. Interest
  2. Dividends
  3. Royalties (note that the provision of services in conjunction with the royalties generally taints all of the income)
  4. Rents from real property (note that the provision of services in conjunction with the rental activity generally taints all of the income)
  5. Capital gains
However, if borrowed funds are used by the IRA or the investment vehicle to generate any of the income, it generally will be taxable to the IRA.

What is unrelated debt-financed income (UDFI)?

If the IRA, directly or through a partnership or LLC investment, utilizes debt (whether recourse or non-recourse) to acquire or improve an income-producing asset, the IRA’s share of the income from that asset will be unrelated business income to the extent of the borrowing if not already considered UBTI. For example, if a real estate partnership borrows $400,000 to acquire a building for $1,000,000, 40% of the IRA’s allocable rental income from that building generally will be subject to UBIT.

How to identify unrelated business income?

Partnerships are required to provide sufficient information such that partners subject to UBIT are able to compute their tax liability. Specifically, Form 1065, Schedule K-1 contains a code “V” in Box 20 for partnerships to report this information. In addition, for 2022 Schedules K-1 furnished to IRAs, partnerships should also include code “AH” and provide the IRA’s EIN when there is UBTI.

How and when to report and pay the tax?

IRAs generally must file Form 990-T if they have gross UBTI in excess of $1,000. The return generally must be filed by April 15, unless extended to October 15 by filing a Form 8868 on or before the original due date.

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This article was written by Alexandra O. Mitchell, Morgan Souza and originally appeared on 2023-04-06. Reprinted with permission from RSM US LLP.
© 2024 RSM US LLP. All rights reserved. https://rsmus.com/insights/services/business-tax/iras-are-subject-to-the-unrelated-business-income-tax.html

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The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

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