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Tuesday, May 16, 2017

Common Triggers of Unrelated Business Taxable Income (UBTI)


Unrelated Business Taxable Income (UBTI) applies to a variety of otherwise tax-exempt entities including qualified retirement plans and individual retirement accounts (IRAs). As applied to qualified plans and IRAs, UBIT provisions essentially tax UBTI exceeding $1,000 in a year at trust rates (which reach 39.6% at the low threshold of $7,500).

Given that many plans may have minimal amounts of UBTI, the burden of compliance is often the biggest problem.  Gathering information and filing Form 990-T falls upon the plan administrator of a qualified plan or the custodian of an IRA.

You may wonder what sorts of things commonly cause UBTI in qualified plans and IRAs. Theoretically, conduct of an active trade or business can be the source of UBTI, but there are other triggers:

  • Investment in pass-through entities which generate Forms K-1 can cause UBTI for qualified plans or IRAs.  This is sometimes the case with exchange traded funds (ETFs).
  • Debt-financed income, potentially from a real estate investment (which by itself ordinarily would not generate UBTI) that carries indebtedness. This is generally only a problem for IRAs.

Imagine, for a moment, a 401(k) plan with 40-50 self-directed brokerage accounts. Worse, imagine that the brokerage accounts are held by different custodians selected by participants. The plan administrator must gather all the information from all the brokerage accounts and sift through it at the end of the year to determine which and to what extent the investments produce UBTI. After that, if the aggregate amount of UBTI exceeds $1,000, Form 990-T must be filed and the tax paid.

Much of the cost may not be associated with self-directed brokerage windows. However, depending upon the extent of brokerage accounts, the types of investments and the ready availability of information, audit fees could be quite a bit higher for an audit-sized plan with self-directed brokerage accounts.

For more information about how UBTI could impact self-directed brokerage accounts, or for general inquiries about compensation and benefits planning, contact your local Armanino expert.

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