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Got UBIT? Why IRAs need to be careful where they invest

August 19, 2010

A reader writes :

Hello, I saw online that you answered tax questions. I would really appreciate it. I didn't find this answer really in the instructions. I am a preparer and this is my first UBIT return.

I have a ROTH IRA that is self-directed. There is UBIT. Have an EIN number from IRS and extension is filed. The income is coming over on schedule K-1s from partnerships and LLCs. Questions are:

First K-1 has in box one and box 20V income of $1,400

Second K-1 has losses in box 1 and box 20V of $800. So a negative number.

Question number one: Does the negative, since if we add the two together, mean the return doesn't need to be filed because income is below $1,000?

Question number two: Since one k-1 goes over a thousand dollars is it a good idea to file it anyway?

(Note - numbers and wording changed slightly from original note.)

"UBIT" is the "unrelated business income tax," which is pretty much the corporation income tax applied to non-profits who have business income. The idea is to keep tax-exempt entities from competing unfairly with taxable businesses. Business income is pretty much anything other than contributions, interest, dividends, and capital gains. Rent income can be taxable to non-profits that have debt, including secured debt on rental property. If a tax-exempt organization -- including an individual retirement account or retirement plan -- gets a K-1 with business income from a partnership (LLC) or S corporation, it likely will have to file a Form 990-T and pay UBIT.

There are two $1,000 thresholds that confuse many taxpayers. There is a $1,000 "specific deduction" in computing UBIT (Sec. 512(b)(12)). This means an exempt organization will not have to pay UBIT unless its taxable income exceeds $1,000. Unfortunately, there is a second threshold, outlined in the Form 990-T instructions:

Who Must File
- Any domestic or foreign organization exempt under section 501(a) or section 529(a) must file Form 990-T if it has gross income from a regularly carried on unrelated trade or business, of $1,000 or more. See Regulations section 1.6012-2(e). Gross income is gross receipts minus the cost of goods sold.

That means an IRA that has taxable income from K-1s under $1,000 is likely to have gross income over $1,000; gross income is computed without deducting any general and administrative expenses.

While partnership K-1s are supposed to report unrelated business taxable income (1065 K-1 box 20, code V), they often fail to report gross income (it may show up on box 14, codes B and C, or box 16, codes B and C); sometimes they fail to make a UBIT computation. S corporation K-1s have no UBIT information, so taxpayers have to either assume all line 1 income is UBIT or get additional information from the corporation.

In the case of our questioner, it is probably smart to file the 990-T, because the IRA's share of partnership gross income is probably over $1,000. There will be no tax due, based on the numbers provided, but filing will avoid any failure-to-file penalties and get the statute of limitations running.

In general, it's best to avoid these issues for your IRA by not making investments that can generate UBIT. If you are going to generate a tax, do so on the personal return that you have to file anyway; don't generate a tax return for an IRA that would otherwise not have to file one.