On December 02, 2020, the internal revenue service (IRS) published final regulations surrounding the computation of unrelated business taxable income (UBTI) for a tax-exempt organization which also includes 401k plans including solo 401k plan as well as IRAs (e.g., self-directed IRAs & IRA LLCs) that invest in an active business. The final regulations also clarify that the definition of “unrelated trade or business” applies to retirement accounts. See Section 513(b).
The purpose of the updated UBTI regulations is to help simplify the administration and reporting of this type of tax and is effective for taxable years starting on or after December 2, 2020.
The Applicable Provision in the Newly Released Regulations:
Multiple unrelated businesses are treated separately. The final regulations require an exempt organization subject to the unrelated business income tax—if it has more than one unrelated trade or business—to calculate UBTI separately for each one. But the rule also prohibits offsetting the income of one unrelated business with the net operating loss of another.
For dates of applicability, see §§ 1.170A-9(k)(3), 1.509(a)-3(o), 1.512(a)-1(h), 1.512(a)-6(i), 1.512(b)-1(a)(3), 1.512(b)-1(g)(5), and 1.513-1(h).
Background-The Purpose of Applying UBTI to Retirement Plans Including Solo 401k Plans and IRAs
IRAs and solo 401k plans were created to grow retirement accounts through the generation of passive income not active income. Therefore, as long as retirement accounts stay within the passive investing umbrella, the investments made through the accounts will maintain their current tax-exempt status and will not be subject to UBTI. However, if solo 401k plans and IRAs invest in a business that offers goods or services, they will be required to pay taxes on business income derived from such investments to level the playing field with investors that don’t use retirement funds to invest in an active business.
Example of Investments in a Solo 401k and IRA Subject to UBIT
Investments that result in UBTI are those that generate business income such as a business and stocks or securities that are purchased on margin.
Form 990-T for Reporting UBTI
- Form 990-T: Exempt Organization Business Income Tax Return, must be filed for solo 401k plans and IRAs with gross income of $1,000 or more from an unrelated trade or business. Form 990-T must be filed by April 15 for calendar-year tax filers.
- The first $1,000 of gross income from an unrelated business is exempts the solo 401k or IRA from the paying UBTI, but a Form 990-T must still be filed. For income over $1,000, the tax rates paid range from 10% to 37%.
- The solo 401k trustee and IRA participant works with his or her tax professional to prepare and file Form 990-T.