Life and Death Planning for Retirement Benefits

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Chapter 8: Investment Issues; Plan Types 397
8.2 IRAs and the Tax on UBTI
Normally, IRAs are tax-exempt entities; however, like other tax-exempt entities, IRAs are
subject to tax unde on “unrelated business taxable income” (UBTI). This
provides , for the estate planner, CPA, or financial planner who is advising an individual participant
or beneficiary, an overview of the tax, emphasizing rules that personal advisers may not be aware
of. An IRA owner and his adviser must seek UBTI-expert help (or become UBTI experts) if the
IRA invests in nontraditional investments. For more on UBTI, see IRS Publication 598, Tax on
Unrelated Business Income of Exempt Organizations.
8.2.01 UBTI: Rationale, exemptions, returns, double tax, etc.
The idea of the UBTI tax is that a tax-exempt organization (such as a charity or retirement
plan) is granted its tax exemption to foster its exempt purposes, not to enable the entity to compete
with tax-paying businesses. Reg. If the tax-exempt entity has UBTI, it must pay
income tax on that income However, despite this rationale, an IRA does not have to actually
operate a business to become subject to this tax; see
The UBTI tax can require not only the complications of figuring out the tax, and filing
returns (Form 990-T, 990-W) but also paying estimated taxes (if “adjusted” UBTI exceeds $500),
with associated penalties if any of these filings or payments are late. If the UBTI for the year is
under $1,000 there is no tax, because there is a $1,000 deduction. Form 990-T must
be filed if gross unrelated business income is $1,000 or more. The IRA custodian or trustee is
supposed to file the return. Strangely, it is not clear whether an individual’s IRAs are aggregated
for purposes of applying the $1,000 deduction.
Nothing in the Code gives the IRA owner any “basis step-up” or tax credit to reflect the
fact that some of the IRA’s income has already been taxed as UBTI. An IRA or Roth IRA
distribution will be taxable (or not) under the usual rules for taxation of such distributions (see
without regard to how much if any UBTI tax has been paid on the IRA’s internal income.
The UBTI tax is not a concern if the IRA invests only in publically-traded corporate stocks
and bonds and bank deposits, and never borrows money. However, UBTI can be generated by
certain publically-traded securities; see A).
8.2.02 Income from an IRA-operated trade or business
UBTI includes gross income (minus permitted deductions) from the conduct of an
“unrelated trade or business” that is “regularly carried on” by the exempt organization.
provides that, for a QRP, “unrelated trade or business” means “any trade or
business regularly carried on by such [plan] ...or by a partnership of which it is a member.”
Emphasis added. Though there is no comparable specific rule for IRAs, which are tax-exempt
under not it appears prudent to assume that any “trade or business” conducted
by an IRA (or by a partnership or LLC of which it is a member) is unrelated to its exempt purpose.
Under unrelated trade or business “does not include any trade or business—
(1) in which substantially all the work in carrying on such trade or business is performed for the
organization without compensation ....” This might make it appear that, if the IRA owner is the