UBIT and UDFI Differences

As a general rule, UBIT applies to both IRAs and solo 401k plans; however, UDFI applies to IRAs but not to solo 401k plans.

What is Unrelated Business Income Tax?

Unrelated Business Income Tax (UBIT) is assessed when a tax-exempt entity, such as an IRA or solo 401k plan engages in a business activity that is not related to its general purpose.

For example, if a self-directed solo 401k invests via an equity investment in a shoe store or a computer store the income generated from the business would be subject to UBIT. Reason being, selling shoes and computer equipment or services is not the general purpose of a solo 401k plan. In order for the retirement plan to not be subject to UBIT, the IRA or solo 401k investment must be passive in nature. This tax was created to keep tax-exempt entities on a level playing field with non-tax-exempt entities such as solo 401k plans and IRAs.

Private Investment QUESTION

Can i invest a solo 401k in private company shares?

While a solo 401k is allowed to invest in shares of a private company that neither your or family members are officers, directors, employees or 50% more shareholders when the ownership percentages are aggregated, such an investment made through a solo 401k plan will trigger unrelated business income tax (UBIT) if the entity type is an LLC. However, UBIT won’t be triggered if the entity type is a C-corporation. Lastly, the entity type cannot be an S-corporation as this type of entity does not allow for retirement plans including solo 401k plans or IRAs to be shareholders.

Paying UBIT QUESTION

How is the UBIT paid?

The payment uses funds from the solo 401k plan and is made directly and electronically to the IRS using the Electronic Federal Taxpayer Payment System (EFTPS).

UBIT Payment Due Date QUESTION

When is the UBIT payment due to the IRS?

The payment is due by April 15.

Reporting UBIT to the IRS QUESTION

How do I report UBIT to the IRS?

IRS Form 990-T is used to report the UBIT tax.

Form 990-T Due Date QUESTION

When must I file Form 990-T with the IRS?

Form 990-T is due by April 15, plus extension. The extension extends the filing deadline until October 15, and it is filed separately NOT with your personal or business taxes.

What is Unrelated Debt-Financed Income Tax?

Similar to UBIT there is another tax called Unrelated Debt-Financed Income (UDFI) tax that ONLY applies to IRA investment income derived from debt-financed property, proportional to the debt on the property. HOWEVER, UDFI does not apply to solo 401k plans so this is why individuals prefer solo 401k plans over IRAs for investing in real estate whereby a non-recourse loan (debt financing) is used.

Solo 401k UBIT Tax Rates QUESTION

What are the UBIT Tax rates for 2022 and 2023?

For 2022, the IRA and the Solo 401k UBIT tax rates as follows:

$0 – $2,550 = 10% of taxable income
$2,551 – $9,150 = $255 + 24% of the amount over $2,550
$9,151 – $12,500 = $1,839 + 35% of the amount over $9,150
Over $12,501 = $3,011.50 + 37% of the amount over $12,500

For 2023, the IRA and the Solo 401k UBIT tax rates have not yet been published by the IRS, but once published, they can be found in the following IRS instructions to Form 990-T. https://www.irs.gov/pub/irs-pdf/i990t.pdf on page 9 or 10.