Some IRAs and tax-advantaged plans make investments that do incur tax. Unrelated Business Income Tax (UBIT) is the name for the tax assessed on profits derived from certain assets of IRAs or other plans. Specifically, a tax is levied either on the debt-leveraged portion of the net income of an asset or on an operating business within an IRA, qualified plan, or other tax-advantaged account. This tax is paid by the IRA or HSA, not by the IRA holder out of their personal funds.
When an IRA or 401k derives profit from an operating business that has not paid business tax on those profits before distributing them to the retirement account, those profits are taxed at trust rates.
When an IRA purchases real estate using a non-recourse mortgage loan, the debt financed portion of the property's profits is subject to unrelated business income tax. Similarly, if an IRA-owned property is sold while a percentage of ownership is still debt financed, the profits derived from the debt financed percentage is subject to unrelated business income tax.
|Many people have heard about Unrelated Business Income Tax (UBIT) but few truly understand how it can apply to a retirement account. It is true that IRAs sometimes pay tax, but don’t let that scare you from using your retirement account to its fullest potential. This presentation, sponsored by IRA Tax Services, defines when UBIT applies, not to estimate cost and strategies to avoid it altogether.|
UBIT is not a penalty; it is simply a tax on the machinations of the account.
UBIT is calculated by filling out a form 990-T. It can be advantageous to fill out this form even if the IRA is not going to incur any tax, because losses can be used to offset profits in other years.
When an IRA owns an ongoing business, tax on that business must occur. The tax can be taken at the company level before profits are paid to the IRA (in that case UBIT would not occur.) Or, the company can pay profits to the IRA before business taxes, at which point the IRA would be subject to UBIT.
In the case of debt leverage on real estate, UBIT is only calculated on the percentage of profits associated with the ownership percentage of the leverage. Expenses and depreciation can be used to minimize the profit calculation on the debt leveraged percentage of the property.
The debt leveraged percentage is calculated as an average over the previous 12 months.
Unrelated Business Income Tax rates for almost all retirement account investments follow a schedule of "Trust Rates" provided by the IRS on an annual basis. The exception is percentage of profits that are attributed to the outstanding loan percentage at the sale of leveraged real estate; this is taxed at the long-term capital gains rate.
Speak your with CPA or Tax Advisor about filing form 990-T as soon as you consider investing in an asset that may be subject to UBIT.
For detailed information and IRS worksheets, see the Form 990-W worksheet. Trust rates change from year to year but slide from 15-35%.
2016 - Estate and Trust
|If taxable income is:||The tax is:|
|Not over $2550||15% of the taxable income|
|Over $2550 but not over $5950||$382.50 plus 25% of the excess over $2551|
|Over $5950 but not over $9050||$1232.50 plus 28% of the excess over $5951|
|Over $9050 but not over $12300||$2100.50 plus 33% of the excess over $9051|
|Over $12400||$3206 plus 39.6% of the excess over $12400|
2015 - Estate and Trust
|If taxable income is:||The tax is:|
|Not over $2500||15% of the taxable income|
|Over $2500 but not over $5900||$375 plus 25% of the excess over $2500|
|Over $5900 but not over $9050||$1225 plus 28% of the excess over $5900|
|Over $9050 but not over $12300||$2107 plus 33% of the excess over $9050|
|Over $12300||$3179 plus 39.6% of the excess over $12300|