Unrelated Business Taxable Income

Unrelated business taxable income (UBTI) is taxable income earned by a tax-exempt or tax-advantaged entity, such as a charity or an IRA, that is not related to the exempt purpose of the tax-exempt entity or gives the entity an unfair advantage over competing businesses that do not have the same tax advantages. Thus, UBTI does not apply to taxable accounts like regular brokerage accounts.

UBTI usually comes from investments in limited partnerships or master limited partnerships, especially if the partnership borrows money for leverage, and occasionally from real estate investment trusts. UBTI is generated from the operations of a limited partnership, gains from liquidating a partnership interest or a master limited partnership, and unrelated debt-financed income from the sale of a partner's interest attributable to acquisition indebtedness. Income from the cancellation of debt is also UBTI.

UBTI is taxable when it is earned, even when held in a tax-exempt account, such as a Roth IRA. Double taxation occurs when UBTI occurs in a tax-deferred account, such as a traditional IRA or other tax-deferred retirement account since the UBTI will be taxed when it is earned and again when it is withdrawn as a retirement distribution.

However, each account or entity can receive up to $1000 of UBTI without tax liability.

Tax-exempt charities may incur UBTI, but these tax-advantaged accounts for individuals are also subject to UBTI rules:

Retirement and tax-advantaged accounts are independent trust accounts. When these types of trust accounts generate UBTI, the custodians of these accounts must file Form 990, Return of Organization Exempt from Income Tax and pay the tax. The entity or account must apply for a separate Employer Identification Number (EIN) since it is the entity or account that directly pays the tax and is needed to file Form 990-T.

If an entity has more than 1 investment generating UBTI, the amounts must be added, but losses cannot be deducted. Instead, the losses must be carried forward to future years, when they can be used to offset future UBTI from the same investments that generated the losses. Losses from an investment cannot be used to offset gains from another investment generating UBTI.

The custodian will use cash within the account to pay the tax, but if the tax exceeds available cash, the custodian will notify the account owner that additional money is needed. The custodian will file Form 990-T even if there is no cash for the payment, but the account owner will be responsible for interest and tax penalties for failure to pay the full tax due. Payments of the tax are not treated as distributions, but they may be listed in brokerage accounts as a partial transfer of assets or as a non-reportable distribution, so they will not be reported on Form 1099-R. If needed, the custodian may also request additional information to file Form 990-T.

The account owner will receive information about UBTI on Form K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc. from the partnership.

Note that these deductions apply to each investment generating UBTI. Deductions from other UBTI assets cannot be combined. Losses from each asset must be carried forward and can only be used to deduct future income from the asset that created the loss.

Allowable deductions from the positive UBTI include:

References