Individual Retirement Account (IRA) & Unrelated Business Income

Posted by Lee Reams Sr. on

Generally, an IRA is exempt from tax except for unrelated business income (UBI).

UBI is typically income that is received from activities that are not substantially related to the IRA’s tax-exempted functions, such as engaging in a for-profit business. Most often, the issue of UBI arises when IRA funds are invested in limited partnerships (especially publicly traded master limited partnerships), limited liability companies, and investments that incur debt financing or that involve an unrelated business. In an IRA, an investment that generates income from debt financing, such as the purchase of real estate with a non-recourse loan, will incur UBI tax in proportion to the debt-financed gain and/or income. If it is $1,000 or more, the UBI associated with a Traditional or Roth IRA arrangement or with a SEP IRA or SIMPLE IRA must be reported on Form 990-T. If the UBI is generated from a partnership, either the 1065 K-1 or a statement included with the K-1, should report both the UBI income and the allowable expenses.

To file the 990-T, the IRA’s owner will need to create an EIN for the IRA because the owner’s SSN cannot be used. Any tax owed on UBI must be paid from the IRA, not from the individual owner’s personal funds.

Who is responsible for completing the 990-T when it is required? The form’s instructions indicate that “trustees” (including custodians) of IRAs, SEP IRAs, etc. with $1,000 or more of unrelated trade or business gross income must file 990-Ts. However, if an IRA is self-directed, the individual owner may be considered the trustee. If there is UBI in an IRA, the account owner should check with his or her trustee to determine if that fiduciary has filed the 990-T. If not, then the job will fall to the taxpayer and to his or her return preparer.

When completing a 990-T for an IRA, check “other trust” in box G, enter the UBI on line 13, and complete the balance of Form 990-T. Compute the tax on line 36 using the tax rate schedule for trusts on page 19 of the 990-T Instructions (2015).