Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

only worker in the business conducted by his IRA, and he does not take a salary or withdraw any profits, he could say he is working without compensation, and the IRA should therefore escape UBTI tax on the resulting income. It seems unlikely that this argument would succeed. Presumably a court would not entertain the notion that the IRA owner is serving “without compensation” where 100 percent of the profits of the business flow to him through his ownership of the IRA, even though his compensation is not currently paid out to him. Most types of investment income are specifically excluded from the definition of “trade or business” income. Thus, the owner of an IRA that receives interest, dividends, and capital gains generally has no UBTI worries. § 512(b)(1) , (5) . However, there are exceptions that can make even these types of “passive” investment income subject to the UBTI tax. One such exception involves income from debt-financed property; see ¶ 8.2.04 . The other three are: A. Rent can be UBTI. Rental income from real estate is generally treated as investment income, rather than as income from a trade or business. However, real estate rental income is treated as UBTI if the amount of rent is determined as a percentage of the tenant’s profits. Even stricter rules apply to rental income from personal property. § 512(b)(3) . B. Investment income from a controlled entity. Passive investment income can become UBTI when it is paid to the IRA by a controlled entity. Specifically, if rent, interest, or royalties are received from an entity that is more than 50 percent controlled by the IRA, and such payments have the effect of reducing the business income of the controlled entity, such payments are UBTI to the IRA. § 512(b)(13) . C. Business operated by pass-through entity. If an IRA owns an interest in a business that is a “pass-through” entity for income tax purposes (such as a partnership or an LLC taxed as a partnership), the IRA’s share of the partnership’s (or LLC’s) income from the trade or business is UBTI. This is true regardless of whether the IRA controls the pass-through entity. § 512(c)(1) . See ¶ 8.1.05 (A). When investment income becomes UBTI Income from “debt-financed property” is UBTI regardless of whether there is a trade or business. § 512(b)(4) , § 514 . “Debt-financed property” is property acquired with borrowed funds and held to produce income. § 514(b) . Here are some guidelines: A. Margin accounts create UBTI. An investor may have a loan from his brokerage firm, secured by his securities account, that is used to increase the securities investment activity. This is called a margin account, and if the margin account is held in an IRA, a portion of the plan’s investment income will be taxed as UBTI. Bartels Trust (see “D”). B. Short sales do not create UBTI. Selling securities short involves two investors at the “selling” end: one (the lender-seller) lends its securities (through the brokerage firm) to the second investor, and the other (the borrower-seller) sells the borrowed securities to the buyer. The lender-seller receives various payments in connection with this transaction, but generally is treated as if he still owns the securities. The lender-seller is exempted from the UBTI tax by § 514(c)(8)(A) and § 512(a)(5) , if various requirements are met. Short selling Income from debt-financed property